Cutting the Tax Bill on Company Stock

After putting in almost 30 years at a major railroad company, Mickie Wittig decided to accept an early retirement package. It wasn’t an easy choice. “I loved what I did, and I loved the people I worked with,” says Wittig, 54, of Jacksonville, Fla. “And I had to make the decision in a very short amount of time.”

But she had another challenge after taking the buyout. Nearly half of her 401(k) assets were in company stock, which had grown in value by 300%. Rolling her entire 401(k) into an IRA would cause about $400,000 in appreciation to be taxed at ordinary income tax rates, which climb as high as 37%, when distributed from the IRA.

But fortunately, Wittig’s financial planner, Tiffany Beard, of financial-planning firm Retirement Strategies, in Jacksonville, alerted her to a tax-saving strategy known as net unrealized appreciation, or NUA. The strategy allows company stock held in a workplace retirement plan to be split off and rolled over to a taxable account to take advantage of capital-gains tax rates, which top out at 20%.

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“People aren’t always aware of NUA,” says Martha Ferrari, a financial planner with Partners for Planning, in Princeton, N.J. “But it can be a great tax break.”

NUA refers to the difference between the price when you initially got the employer stock and its current market value. You can use the NUA strategy under certain circumstances, such as when you’re leaving an employer with a company plan that holds the stock, if you are at least age 59½ and your plan allows in-service distributions from your company plan, or in the case of disability or death.

The NUA move works like this: Instead of rolling the company stock to an IRA, you transfer the shares into a taxable account. At the time of transfer, you owe ordinary income tax—of up to 37% in 2018—on the cost basis of your employer stock. When you sell shares from the taxable account, you owe tax on the NUA at the long-term capital-gains rate of up to 20%.

Say you had company stock that has grown to $500,000 with a cost basis of $100,000, giving you net unrealized appreciation of $400,000. Rolled to an IRA, the total ordinary income tax bill on distributions of that $500,000 from the traditional IRA at a 37% ordinary rate would be $185,000.

But if you move the shares to a taxable account, you’d pay $37,000 in ordinary income tax in the year of the transfer. If you sold all the shares in the taxable account at a 20% capital-gains rate, the tax bill on the NUA would be $80,000. Total tax paid in this hypothetical example would be $117,000. That’s about 37% less than if the appreciated stock moved to an IRA, resulting in tax savings of $68,000.

Whether to use the NUA strategy will depend on how much your company stock has appreciated, the tax brackets you fall into and whether you can afford to take an immediate tax hit.

The NUA itself is automatically eligible for long-term capital-gains treatment, so there’s no requirement to wait one year to sell the stock to avoid higher short-term capital-gains rates (short-term gains are taxed as ordinary income, topping out at a rate of 37%), says Jeffrey Levine, director of financial planning for BluePrint Wealth Alliance.

But future growth after the NUA transaction is completed is subject to the “regular” capital-gains rules—so the stock must be held for longer than one year after the NUA move for any future appreciation to be treated as long-term capital gains.

For example, let’s say you had employer stock in your plan that you received at $20 a share in 1998. You had the employer stock distributed in-kind under the NUA rules on June 1 at $100 a share, and the share price then rose to $105 at the end of July. The $80 gain from the original $20 cost basis of the stock would automatically be considered as long-term capital gains, says Michael Kitces, partner and director of wealth management for the Pinnacle Advisory Group, in Columbia, Md.

But the $5 gain since the distribution would be considered a short-term capital gain—and won’t qualify for long-term capital-gains treatment unless the shares are held until June 1 of the following year, to satisfy the one-year holding period after the distribution under the NUA rules.

When it comes to paying taxes, capital-gains tax on the NUA is owed at the time the shares are sold from the taxable account, Levine says. So if you move employer stock under the NUA rules today and the shares are sold from the taxable account in 10 years, the long-term capital-gains tax on the NUA won’t be due until a decade from now. Plus, any additional gains since the NUA distribution would be treated as long-term capital gains since the shares would have been held for more than a year.

Extra Benefits

Besides saving a bundle in taxes on the appreciation, moving company stock from an employer plan to a taxable account can provide other advantages. In Wittig’s case, because nearly half her 401(k) balance included appreciated company stock, moving those shares to a taxable account means she rolled only the remaining half of the 401(k) into an IRA—and that means her required minimum distributions will be slashed, too.

After moving the appreciated stock to a taxable account, consider the timing of when you sell off shares and look for tax-saving opportunities. You could sell off shares gradually at or near a 0% capital-gains rate in years when you are in a lower tax bracket, says Eric McClain, a partner with financial-planning firm McClain Lovejoy, in Birmingham, Ala.

Taxpayers qualify for the 0% capital-gains rate on up to $38,600 of taxable income for single filers and up to $77,200 for a married couple filing jointly in 2018. “The real value here is if you can take the NUA and stretch it out over some period of time,” says McClain. “You’ll be in a sweet spot tax-wise.”

Another option is to donate the appreciated shares from the taxable account, perhaps in a year you want to bunch deductions to itemize. In that case, you wouldn’t pay any capital-gains tax on the appreciation, and you can help cut your overall tax bill if you’re itemizing that year.