Taxation of distribuitons

[Guest fore01k]

ESOP is being terminated by company. My understanding is that the participant can take the shares without rolling them to an IRA in order to benefit from capital gains rates instead of ordinary income tax rates. The participant must pay regular rax rates on the basis but can defer any taxes on the Net Unrealized Appreciation of the stock. If they hold the stock for a year they then get the benefit of long term capital gains treatment.

For participants under 59 1/2, does the 10% excise tax apply? I do VERY LITTLE work anywhere near the ESOP field but have been asked by a client to help with this question.

Thanks for your help.

-A bad round of golf beats a good day at the office!

[mbozek]

See question posted by moosegirl on this board for taxation of Esop stock. 10% penalty tax applies only on taxable portion of basis that is not rolled over. Your client needs to see a tax advisor to determine whether the stock should be distributed or rolled over if you are not aware that all NUA as of the date of distribution is taxed at LTCG rates.

[Guest fore01k]

mbozek - Thanks. I've told them to seek advice ffom the CPA but now I want to understand for my own education. I'm getting conflicting information from the attorney who implemented the ESOP about the LTCG treatment. He said that the participant had to hold the shares 1 year to get the LTCG treatment

You're saying that the NUA is treated as LTCG immediately if they sell the stock the day after the distribution or 10 years from now. OK. Is this a special rule for stock from an ESOP?

Example:

EE age 50

None of this is ee contribution.

20,000 basis

100,000 value at date of distribution

He takes the stock and does not roll it into an IRA. He pays regualr income tax on the basis plus a 10% excise tax. He sells the stock a week later and gets to treat the gain as LT. Is that correct?

What if he rolled enough stock to an IRA to cover his basis? Any CURRENT regular income tax or penalty?

Sorry to ask such "basic" questions but as I said, I don't deal with this and the attorney is giving me other information.

[mbozek]

See Notice 98-24 for LTCG on NUA. Atty is thinking of LTCG holding period for capital assets. Additonal appreciation after the date of distribution is treated as LTCG if the shares are held for more than 1 yr after the date of the distribution.

20k is taxed as ordinary income +10% penalty. 80k is taxed as LTCG at max rate of 15%. Dont understand your rollover Q. Pro rata amount rolled over is exempt from taxation. Eg. 20 k rollover leaves 80K distribution w/16k basis. 20k will be taxed as ordinary income from IRA.

[RLL]

Special treatment of NUA may not be available to everyone in this situation. NUA attributable to employer stock purchased with employer contributions (including 401(k) elective deferrals) is granted special treatment under IRC section 402(e)(4) only in the case of a "lump sum distribution."

A total distribution is a lump sum distribution only if the participant has attained age 59-1/2, died, become disabled or has otherwise separated from service. In the case of the termination of an ESOP, there are likely many participants whose total distributions will not be lump sum distributions under section 402(e)(4)(D).

In addition, the exclusion of NUA from the 10% additional tax under section 72(t) may not be available to all participants.