ESOP Distribution and Taxes

[Guest Marcus Burns]

I was terminated from my employer in late September and have decided to return to school. I will have to take a distribution from my ESOP or 401K account to do this.

My question is about taxes and penalties from the ESOP. I have been told that I will only have to pay the 10% penalty on the price my employer paid for the shares in my ESOP account. This could make a huge difference as the account is 8 years old and the stock value has gone up quite a bit.

Is this true? If so, how would I get the amounts my employer paid? Is this called the UAM Value?

Thanks very much!

[BeckyMiller]

Glad to hear that your stock has increased in value.

If your plan provides for a lump-sum distribution in employer securities(certain plans can make cash distribution only), the taxable portion of the distribution is the cost basis of the stock to the plan. This amount would be reported to you on the Form 1099-R. It is a good idea to ask about this value, however, when you take the distribution. This is because that cost basis number is not always obvious from the activity that you have seen in your account. The stock may have dropped in value in the very first year, before you saw any allocation or your employer may be an S corporation (a special kind of tax entity) where the basis is recalculated every year for income tax purposes.

Anyway, once you get through that, the information you received is correct. If you get to exclude the "Net unrealized appreciation" from taxable income, it is also excluded from the premature distribution penalty of 10%.

This is GENERAL guidance, you should check with your tax advisor. There may be other reasons why it would be better to take a different approach on the distribution - installment payments, rollover to an IRA and take funds out as you need to make tuition payments, etc.

Good luck!

[QDROphile]

You said you needed the distribution to pay for school. Don't forget that when you sell the shares to get the cash to pay for school, the difference between the basis and the sale price is taxable gain. Depending on the holding period, long term gain rates may apply. You don't get the appreciation tax free.