Distribution of employer stock and 10-year averaging

[Guest Steve Palmer]

Recent retiree from a large publicly traded company has stock and cash in his retirement plan. Cash is $200,000. 10,000 shares of stock has a basis in the plan of $15 per share and a FMV of $40. He can take the stock, pay tax on the plan basis and defer tax on the $25 per share appreciation.

Question 1: Is the $25 capital gain or ordinary income on the subsequent sale of the stock? (I have always thought it was ordinary income, and eventually IRD, but someone has suggested otherwise)

Question 2: If a lump sum distribution of the cash and stock is received, is the 10-year averaging tax based on the total FMV of the cash and stock or the cash plus plan basis?

Thank you

[Guest]

1. The $25 appreciation is taxed as long-term capital gain when the stock is sold. This is the advantage (together with deferral of tax until the stock is sold) of NUA. However, the NUA will be taxed as IRD when the stock is sold by the heirs.

2. The NUA is not included in the taxable amount when calculating the 5- or 10-year averaging tax. Note that an election can be made to waive NUA treatment. This might make sense if the averaging tax rate is lower than the capital gains rate.