Questions About ESOP Early Distribution

[Guest rkesler]

Hello. My company was recently sold, and now employees have the choice between receiving a lump sum distribution from ESOP, or rolling over into 401K. I have chosen to take the payment and have been advised that they will withhold 20% for federal taxes. I was also told that there will be a 10% early withdrawal penalty, which I will be responsible for paying when I file my taxes the following year. However, I am not sure how state taxes, and FICA are handled. Will I also be responsible for these? Plus, it is my understanding that this distribution will be added to my income and taxed as such, is this true? If that is the caase, would it be possible to responsible for more than the 20% federal, because I know I would be in a higher tax bracket. This is all really confusing...any help would be GREATLY appreciated!!! Thank you for your time.

[A Shot in the Dark]

As part of the plan termination process, at some point you will receive a distribution election package. Generally, included in that pacakge will be:

A. Distribution Election Form

B. Special Tax Notice

The Special Tax Notice will answer most of your questions.

You will also be advised to speak with a professional tax advisor. I would encourage you to do so.

In most cases:

You will be given an option to withhold more than the 20% (federal income tax) at your election.

If you live in a state that has anincome tax, you will likely be given an election to withhold a percentage for state income tax.

Generally, the distribution you receive should you not elect a rollover, will be taxed as ordinary income.

[GMK]

You are correct that the total distribution amount (what you receive plus what is withheld) will be taxable income to you. It will add to your other ordinary income for the year.

As a result, depending on the tax bracket you end up in, your taxes on the distribution could be more than the 20% that the plan is required by law to withhold. And if you are under age 59-1/2, you will also add the 10% penalty to your federal tax bill (that's 10% of the total distribution amount).

If your state has an income tax, the added income will increase your state income tax. Some states also have an early withdrawal penalty.

In most cases, the taxes take a huge bite. If this is looking like too big a bite, you might reconsider rolling over to a 401(k). In that case, you are not liable for the taxes until you take the money out of the 401(k). There may be different rules for taking distributions from the 401(k), but the big advantage of the rollover is in postponing the taxes.

If you have the distribution paid to you, you have 60 days to rollover all or a portion of the money you receive into an IRA. The amount you rollover in 60 days is not considered as taxable income this year, and the 10% penalty will not apply to that rollover amount. You actually have the right to rollover the total distribution amount within the 60 day limit, but in that case you have to come up with the withheld amount from other sources, like from your other savings.

The special tax notice you receive from the ESOP will cover these topics and others in more detail. These notices are usually small print and cover topics that you are not interested in, but I recommend reading it carefully. As A Shot in the Dark said, the Notice will answer most of your questions.

[Guest rkesler]

Thank you both for your help!

[Robert]

This year will be my 3rd of 6 ESOP distributions. After this year I plan on rolling the rest into an IRA.

But I have a question about the 10% early penalty…. The first 2 years they mailed the paperwork and all I had to do was choose direct cash payment and give them the banking info for Direct Deipsit..

This year you can go online and make your selections etc… but doing it this way seems to have an option I don’t remember having previously.
 

It informs you about the 20% Federal that will be withheld, and about the early 10%.. but it’s giving me the options to add additional %’s if I choose. 

So would I be better off adding the additional 10% early penalty tax now with the direct payment or wait and File it on the following years tax return?

 

TIA

[ESOP Guy]

You need to go talk to a tax advisor who can look at your total financial situation.  It is very hard to give good advice online.  It is worth what you pay for it:  nothing.

This is one of the cases where a good tax person is worth the cost.  They might see a way to make plans that save you more in taxes than you pay them.