Tax laws have been in the news a lot this year and they just seem to get more and more complicated. While not everyone needs to be a tax expert, we think it’s important to have a basic understanding of certain areas, especially those that can be such a great benefit to you, such as the NUA Tax Break.
Your Net Unrealized Appreciation (NUA) in employer securities is the difference (appreciation) between the cost basis and market value of employer stock held inside your company plan.
The NUA tax break is important if you are distributing highly appreciated company stock from your tax-deferred, employer-sponsored retirement plan (e.g., your 401(k)). NUA only works for the stock of the company you are working for when it is inside of that same employer’s plan.
The mechanics of the tax break on net unrealized appreciation of company stock are relatively simple. If a lump-sum distribution from your company plan includes highly appreciated stock of that company, you can roll it over to an IRA – although that doesn’t necessarily mean you should.
There is a certain exception that applies to company stock and typically works best when that stock is highly appreciated from the date(s) the company plan acquired it. The higher the appreciation and the lower the cost basis in your company shares, the more advantageous the NUA tax break is for you.
Under the special tax rule, you can withdraw the stock from the plan and pay ordinary income tax on it, but only on the original cost to the plan, not on the full market value of the stock.
Manchester Financial’s Chief Economic Strategist, Alan Hopkins, explains. “For example, if your plan paid $20,000 for the stock, but now it is worth $200,000, then you’d pay ordinary income tax on the $20,000 in the current year and pay long-term capital gains tax on $180,000 when the stock is later sold outside the plan.”
You must hold the stock outside the plan for at least one year to secure the long-term capital gains rates. If sold too soon, you’ll pay the much higher short-term rates.
If your company plan includes highly appreciated company stock, consider withdrawing the stock using the NUA rules and rolling the rest of the plan assets over to your IRA.
“A lot of people don’t understand the NUA tax break so they don’t ever get around to using it,” said Robert Katch, President and CIO of Manchester Financial. “We think it’s a valuable option and we always encourage clients to consider it.”
Want to talk about if the NUA tax break makes sense for you? Drop us a line.