401K withholding

[basumukherji]

Background

The assets in a 401(k) consist of mutual funds and employer stocks. At the time of service seperation, in a lump sum distribution, the mutual fund amounts are transferred to an IRA as a direct rollover and the balance is paid as employer stock certificates. The IRA amount is thus exempt from withholding. Under IRC section 402(e)(4), the “net unrealized appreciation” of the employer stocks can be treated as deferred income as an option and hence not subject to immediate withholding. Thus the only taxable amount in the year of the distribution is the “cost basis” for the stocks.

Question

Can an exemption from withholding be claimed on this “cost basis” amount under Internal Revenue Code section 3405(d)(8)?