Net unrealized appreciation (NUA) is one of those lesser-known IRS retirement fund taxation rules. In fact, NUA is really important for people heading towards retirement and planning to take a lump-sum distribution of their company-sponsored stock sharing plan.
What Is Net Unrealized Appreciation?
NUA is the difference between the original value of the stock—its cost basis--and its current price. As such, the NUA is not taxed until you sell the stock and is not subject to a penalty for early withdrawal. Instead, when you sell the stock, the NUA comes under capital gains tax rates, which are lower than regular income taxes. (The cost basis, on the other hand, is subjected to regular taxation.)
How to Qualify For Special Tax Treatment Under NUA
When you distribute the company stock it must be a lump-sum distribution. Lump-sum distribution involves rolling over the employee’s entire account balance and it must be within the calendar year after attaining age 59½ or separation from the company due to death or disability.
Next, the company stock has to be distributed directly from the retirement plan. The NUA rule cannot apply if the stock is converted to cash or rolled over to an IRA. Once the cash enters the IRA it becomes subject to applicable tax rules.
Who Benefits Most From the NUA Rule?
Employees who have large amounts of valuable stock in qualified employee plans can receive significant tax breaks. When it comes time to apply the NUA rule, the taxpayer must report the cost basis of the stock and pay the regular rate. When the NUA stock is sold, the long-term capital gains tax bill becomes due.
An Example Scenario:
You are eligible and ready to take a lump-sum distribution of your stock. Say your stock is worth $150,000. If you rolled that entire amount into an IRA and you were at the 37% tax rate, the federal tax would be $55,500.
On the other hand, taking a lump-sum distribution of the stock would trigger the NUA rule. You would pay two separate tax rates:
- You pay ordinary income tax on the cost basis of the stock ($25,000 in this example). The tax would be $9,250.
- When you decide to sell the stock (immediately or later from a brokerage account), you owe capital gains tax on the overall earnings of the stock—the difference between its original cost and its appreciation.
If you immediately sold those company-sponsored shares, you would pay only 20% capital gains taxes on the remaining earnings. So, tax on the cost basis plus the capital gains tax on the remaining earnings in our example would be $34,250, a savings of over $21,000.
Consult a Financial Advisor About Your Retirement
Like most IRA rules and exemptions, NUA can get a bit complicated in its applications during a down market or when rolling the stock into other taxed brokerage accounts. Chandler & Knowles CPAs are your financial planning experts who can help you make the best decisions on planning a secure retirement future. Contact us today.