Net Unrealized Appreciation (NUA)
Candlefocus EditorThe IRS offers a provision that allows for a more favorable capital gains tax rate on the NUA of employer stock upon distribution, after certain qualifying events.
Under IRS rules, the cost basis for employer stock is the original cost of the shares at the time of purchase. Any appreciation since the time of purchase is the NUA. For example, if an employee owns 1,000 shares of employer stock, purchased at $50 per share, and the current market value is $120 per share, let’s use this example to take a closer look at the benefits of NUA.
Assuming all other requirements are met, when the employee takes a distribution, they will be required to pay ordinary income tax on the cost basis of the shares, which is $50,000. However, the NUA, or appreciated value of the shares, is now $70,000. Under NUA rules, the employee would avoid ordinary income tax on the $70,000 in appreciation, and instead would pay a much lower capital gains tax rate on the $70,000, resulting substantial tax savings.
The main drawback of NUA is that while the employee avoids being taxed at the ordinary income rate on the appreciation of the stock, they must pay that ordinary rate on the cost basis of the shares at the time of distribution. So in this example, the employee must pay ordinary income tax on $50,000, the cost basis of the shares. Still, this could be an advantageous way for a qualifying employee to reduce their tax liability when taking a distribution from a qualified retirement plan.
It’s important to note that the rules for taking advantage of NUA are complex and there are many additional requirements, which vary from taxpayer to taxpayer, that must be met. Additionally, anyone thinking about taking advantage of this program should carefully weigh the potential tax savings against potential losses from selling the stock itself. Consulting a financial or tax advisor is typically recommended before taking this route, as it’s not the right course for every taxpayer.