ESOP Cost Basis

[52626]

Plan requires all employer match contributions be made to the ESOP. Participants can contribute pre and after tax to the core investments. The participant has contributed a total of $64,000 after tax to his account. Participant is retiring and will take a distribution. Shares will be transferred to the participant. Cost Basis for the Shareis $80,000. Recordkeeper stated the particiapnt could use the After Tax contribution to further reduce the cost basis - would now be $16,000.

Question:

If the after tax is used to off set the cost basis, where does it go?? The recordkeeper stated it pays the taxes. Then stated the particiapnt would receive a 1099R for the $16,000 cost basis and have to pay taxes on this.

This does not make sense, why would you pay $64,000 in taxes and no where get credit for the payment.

What am I missing here!!!

Thanks

[ESOP Guy]

The question is confusing.

Is there a 401(k) plan and an ESOP or is it a KSOP?

If there are two plans was the After-tax money put into the 401(k) plan or ESOP?

If there is only one plan was the After-tax dollars used to acquire ESOP shares?

[52626]

This is a KSOP Plan. The after tax was invested in the core investments. Only Employer Match is made to the ESOP. None of the After Tax was used to acquire ESOP Shares

[Kevin C]

It sounds like someone is confusing the cost basis of the stock used for NUA treatment with the after-tax basis in the account. I would suggest going back to the recordkeeper and asking for a written explanation, then let us know what they say.

Is the participant's after-tax basis pre 87, post 86, or some of both?

[ESOP Guy]

I agree it sounds like the recordkeeper is confused about NUA and after-tax basis.

I don't see how they can use the after-tax basis to lower the taxable amount on a portion of the plan that the after-tax wasn't invested in also.

[52626]

thanks for the response

Assume, the after tax was in the ESOP.

Participant has 400 shares

Value $200,000

Cost Basis is $80,000

If the $64,000 after tax is applied to the cost basis what does this mean.

I am assuming the value in the after tax is reduced by $64,000

But where does the $64,000 go?

Is it paying taxes? If so, the amount is much more than the particpant woul need to pay in taxes.

Tryin got get my head wraped around the math. If I read one more article on ESOPs I think my head is going to explode.

Thanks

[Kevin C]

The after-tax basis doesn't affect the cost basis of the stock. The after tax basis does affect how much of the distribution is taxable.

Assume, the after tax was in the ESOP.

Participant has 400 shares

Value $200,000

Cost Basis is $80,000

If the $64,000 after tax is applied to the cost basis what does this mean.

With NUA treatment, the reportable distribution is $80,000. The $64,000 of after tax basis means that of the $80,000, only $16,000 would be taxable.

The more likely situation would be something like:

Vested Balance $300,000

Includes $200,000 of stock (with a cost basis of $80,000).

Distribution amount is $180,000, ($100,000 of other investments + $80,000 for the stock) with $116,000 of it taxable (180,000 - 64,000).

If it's a partial distribution, the after-tax basis is treated different depending on if it is pre-87 or post 86.

[52626]

one more question.

Assume the participant is going to rollover the core investments, tax and stock as a distribution.

In this case:

$36,000 is Rolled to an IRA

$64,000 is a cash Payment

$200,000 ( $ 80,000 cost basis) stock distriubted to the participant.

Is the Cost basis subject to 20% withholdng or the value of the stock at the time it is transferred to the participant.

Thanks

[ESOP Guy]

When you distribute cash and stock the withholding is the lesser of:

1) 100% of the cash or

2) 20% of the distribution (like normal)

Or put another way you don't have to sell shares to get to the 20% but the withholding requirement is still there.

Honestly it has been so long since I did an after-tax distribution I don't recall if you withhold 20% on the after-tax basis. But the rule is simple. Compute the 20% like you would assuming it was all cash being paid to the person. (The amount to the IRA doesn't count obviously) Then apply the limits above.

On the stock I believe it is just the cost basis that counts toward the 20% not the total FMV.

[GMK]

My notes indicates that NUA, if any, is excluded from the amount to which the 20% withholding rate is applied.

This is a reason why ESOP's have to keep track of the cost basis in participants' accounts, which can get tedious when figuring in forfeitures and, in the case of an S corp, allocating pass-through earnings.