Tax reporting on stock distribution with put option

[Guest tmills]

I see some old threads on pieces of the following question, but I would like to try to get an answer (if that's even possible) on the whole thing.

Situation: ESOP (C Corp) distributes shares in a lump sum. Participant exercises put option and is paid annually over the next 5 years (by the employer), w/ interest on payments after the first one. Newer ESOP so FMV is less than cost so no capital gain issues. Questions:

1. Does participant get a 1099-R from the plan showing a lump sum distribution of the total FMV on which they pay tax in the year of distribution? I don't see how the plan would have any other option, the participant's balance has been distributed, in spite of the fact that the participant won't actually receive all the cash for the next 5 years.

2. As the participant receives payments over the following 4 years, does the employer give them a 1099-int for the interest? If not, on what basis do you say so?

3. If the participant rolls the distribution, would the IRA trustee be the one technically exercising the put and they would then hold the paperwork evidencing the "adequate security" and the promissory note? Side issue, I have to think it would be rare to find a trustee willing to do that; among other things they'd have to value the note. If that's not the case, what would you say is being rolled when and how does that work with the 60 day rule?

4. Does a 1099-B come into play? I would think if the 1099-R reporting is as in #1, and the interest is as in #2, there is nothing left to report on a 1099-B. Of course if those aren't right, then maybe the B is used. If so, how? The B instructions say a corporation is not a broker if it purchases odd-lot shares from stockholders on an irregular basis, but it is if it regularly redeems stock. Seems a little grey.

Assistance is always appreciated.

[Marcus R Piquet]

Tom,

I don't know the answer to your questions for sure, but I can tell you how we've handle them.

#1 - Yes. ERISA attorneys have instructed us this way.

#2 - Yes. Why not?

#3 - Yes, I think so. Not terribly difficult to find that kind of trustee though, just more expensive.

#4 - No. We've used the same logic - the entire thing has already been reported on a 1099-R, so a 1099-B seems redundant. I'm not terribly confident on this one though.

Let me know if you find out anything authoritative!

Marcus

[ESOP Guy]

In regards to #4 I know of a few trust companies that specialize in working with ESOPs that would say you would issue the 1099-R from the Plan and the 1099-B from the company. They would tell you for your 1040 you would show the distribution like you normally would. Then for the 1099-B you would show the gross proceeds for the part sold and a cost basis would be the basis for the fraction sold. The basis would be what you already paid taxes on.

Example: A is issued $1,000 worth of shares. To keep it simple he puts all those shares to the company for $1,000. You would show on the 1040 a $1,000 distribution. (Skipping NUA issues etc.) Then on the Sch D for the 1040 you would show the sale of $1,000 with a $1,000 basis, and no realized gain.

From what I could tell this is the most conservative answer. And so the trust company had an interest in making sure they were safe. And the fact was the cost was shifted to the client as they would charge the client to issue both the 1099-R and 1099-B. So you can see why they would take this position. The client pays to keep them safe.

But their position isn’t irrational. As you say the rules here are a little vague.

I have found when this trust company made a mutual client do this the problem was the people getting payments. They would call up mad because they got 2 1099s for the same distribution, they did not figure out the basis for the Sch D. So they would call me demanding to know why they had to pay taxes on the money twice.

So your way seems rational, and simple. So my vote has been for your thinking, but I see the other side’s argument.

Oh, I tend to agree with Marcus on #1 - #3.

[GMK]

the problem was the people getting payments. They would call up mad because they got 2 1099s for the same distribution, they did not figure out the basis for the Sch D. So they would call me demanding to know why they had to pay taxes on the money twice.

The "trick" here is to send each distribution receiver a letter listing the steps for reporting the 1099-B on Schedule D, and especially instructing that basis equals stock distribution amount (taxed on the 1099-R), and net gain = 0. That's easier than trying to explain it over the phone, and it avoids the possibility (likelihood?) of double taxation for those distribution recipients who don't normally deal with Sch. D.

As to whether a 1099-B is required, we assume that since the company is likely to buy back distributed stock each year, for example, for diversification distributions from an ESOP-owned S corp, the company is regularly redeeming stock. If stock redemptions are on more of a hit and miss schedule, most years no stock buy back and some years maybe, then that, to me, would be purchasing on an irregular schedule and not require a 1099-B.

[Guest tmills]

Thanks for the answers. Don't know what started all these answers, but I'll take it. ESOP Guy and GMK, I follow the 1099B if the distribution from the plan and the payment for the shares put are both lump sum. My fact pattern was a lump sum distribution from the plan, a put to the company and payment over 5 years with interest b/c that can be done in the case of a lump sum distribution. Given that how do you feel about the following:

Year 1 - participant "receives" lump sum distribution of stock worth $10,000, puts to company and receives payment of $2,000. Under the logic from your example, Participant would get 1099R for $10,000 from plan and a 1099B from employer for $2000. Net effect being what, a loss of $8000 or $0 gain and some kind of carryforward?

Year 2-5 - participant receives $2000 + interest. He gets a 1099B and int each year. The $2000 is offset by a carryforward or similar mechanism that results in no gain?

If the above is close to correct, it seems like if you start with the 1099B, you should keep it up or the offset won't happen. If the year 1 payment is rolled, I don't see that would change anything. I think everyone agrees that under my scenario, the participant could possibly have more due in taxes in year 1 than he actually receives. Again something they need to be aware of when making their distribution election.

[GMK]

My understanding is that the company payments to buy the shares because of the put option are not part of the distribution. They are a separate transaction. Once the shares are distributed from the ESOP the distribution is complete. The ESOP reports the distribution as it would any other, so start with a 1099R.

Then the payments from the company are 1099B's.

I haven't worked through how to do the 1040 reporting of the basis on the series of 1099B payments, but in the course of the 5 years, the participant should not be taxed on more than the distribution plus interest payments, and only on the interest payments if the original distribution was rolled over.

[ESOP Guy]

I believe, also, you are being tripped up by the idea the payments from the company are the distributions that are the 1099-R event. The plan will issue the 1099-R for the value of the shares in the year they leave the plan. If the person sells all/some/none doesn't matter, he owes taxes on the full distribution. So in your case it sounds like it will be possible that the taxes due in year 1 will be > then the cash recieved by the person.

So if the person gets $10,000 in shares in year 1 he gets a 1099-R for the $10,000 as gross distribution and taxable distribution. If he sells part of them for $2,000, or sells all of them for $2,000 in cash and an $8,000 note he still owes taxes on the distribution in year 1. The 1099-B would reflect either $2,000 in sales proceeds or $10,000 (the $2,000 cash and $8,000 note).

After that his basis in the shares is what he has already paid taxes on, in the example $10,000.

GMK is correct is stressing one should only pay taxes on this stock once, and the practical reality is most of those taxes will be paid in the year they were distributied from the plan. The 1099-R will reflect the taxable amount as the FMV of the shares in the examples you give that don't have NUA issues.