Tag Archive for: Employer Stock

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Does the receipt of dividends on employer stock held in a 401(k) plan negate a lump sum distribution?

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“One of my clients is currently receiving quarterly dividend payments on employer stock he has in his 401(k) plan. Does the receipt of dividends on employer stock held in a 401(k) negate his ability to receive a lump sum distribution and, consequently, my client’s ability to take advantage of the special tax rules for net unrealized appreciation (NUA) in employer securities?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor in New Jersey is representative of a common scenario involving participants with employer stock in a 401(k) plan.

Highlights of the Discussion

While payments of dividends are considered distributions for certain purposes (Temporary Treasury Regulation 1.404(k)-1T, Q&A3), the IRS has, in at least two private letter rulings (PLR 19947041 and 9024083[1]) concluded that such dividends are not treated as part of the “balance to the credit” of an employee for purposes of determining a lump sum distribution under IRC § 402(e)(4)(D). Therefore, such distributions do not prevent a subsequent distribution of the balance to the credit of an employee from being considered a lump sum distribution for NUA purposes if all other requirements are met.

For more information on the definition of lump sum distribution, please see RLC’s Case of the Week Lump Sum Distribution Triggers and NUA.

Conclusion

A participant’s receipt of dividends from employer stock held in a qualified plan do not prevent a subsequent distribution of the balance to the credit of the participant from being a lump sum distribution for NUA tax purposes.

 

[1] See www.legalbitstream.com

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Lump Sum Distribution Triggers and NUA

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“I recently took on a client who has stock of his employer in his retirement plan. Before he came to me, he took an in-service distribution of a portion of his account balance because he had turned age 59½. He continues to work. Does that early distribution eliminate his ability to take a lump sum distribution that includes the employer stock and take advantage of the net unrealized appreciation (NUA) tax strategy?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from California is representative of a common inquiry related to NUA in employer securities.

Highlights of the Discussion

The answer to this question hinges on the definition of lump sum.  A distribution made from a qualified plan is eligible for lump-sum treatment if it meets all three of the following requirements.

  1. The distribution(s) is/are made within one taxable year.
  2. The above distribution(s) represent(s) the “balance to the credit,” of the participant. In other words, the participant must receive the entire account balance (or balances of combined like plans of the same employer) in one taxable year. For this purpose, the IRS treats all pension plans maintained by the same employer as a single (like) plan.  Similarly, all profit-sharing plans maintained by the same employer would be considered a single (like) plan, and all stock bonus plans maintained by the same employer would be considered a single (like) plan [IRC Sec. 402(e)(4)(D)(ii)(I)].
  3. Finally, the distribution(s) is/are made because of
  • The participant’s death,
  • Attainment of age 59 ½,
  • Separation from service (not applicable for a self-employed participant), OR
  • Total and permanent disability (only applicable for a self-employed participant).

In this case, despite using up the “age 59 ½” distribution trigger, your client could still apply the separation from service distribution trigger to qualify for a lump sum if he leaves employment and is not self-employed. Or, if he is self-employed, the total and permanent disability trigger may apply, if he meets the definition. And, his beneficiaries could, potentially, receive a lump sum distribution upon the participant’s death, if the other requirements are met.

Conclusion

A plan participant who is interested in the special tax rules surrounding NUA should discussion his or her situation with a trusted tax professional because the rules are multifaceted. For example, as was discussed here, there are several nuances to the definition of lump sum for purposes of qualifying for NUA tax treatment. Having expert guidance is essential.

 

 

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Valuing employer stock in an ESOP

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“My client has an employee stock ownership plan (ESOP). How does he value the stock within the plan if it is not traded on a securities market?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Wisconsin is representative of a common inquiry related to valuing stock of the sponsoring employer in qualified retirement plans.

Highlights of the Discussion

For employer securities that are not readily tradable on an established securities market, the IRS requires the shares be valued by an independent appraiser [IRC 401(a)(28)(C)]. Valuation by an independent appraiser is not required in the case of employer securities that are readily tradable on an established securities market.

There are a number of factors to consider when determining the value of an asset within a qualified retirement plan. In its examination guidelines, the IRS supports the use of Revenue Ruling 59-60, which relates to valuing assets for estate tax and gift tax purposes, for valuing assets in qualified retirement plans as well.

In valuing the stock of closely held corporations or the stock of corporations where market quotations are not available, all available financial data, as well as all relevant factors affecting the fair market value must be considered. For example, some factors to consider include the following:

  • Nature and history of the business issuing the security;
  • General economic outlook and the outlook for the specific industry;
  • Book value of the securities and the financial condition of the business;
  • Company’s earning capacity;
  • Company’s dividend paying capacity;
  • Goodwill value; and
  • Recent stock sales.

The list of factors to consider in Rev. Rul. 59–60 is not an exclusive list for valuing closely-held employer securities. It may be necessary to consider other factors when appropriate. Also, not all of the listed factors will be relevant to all companies and transactions. The IRS’ examination guidelines note that the independent appraisal will not, in and of itself, be a good faith determination of value unless all relevant factors are considered.

IRS examiners will look at Form 5500 (Schedule R, line 12) to the question: Does the ESOP hold any stock that is not readily tradable on an established securities market? If the answer is yes, examiners are directed to determine if the securities were valued that year and by whom in order to confirm it was done by an independent, third-party auditor.

Conclusion

An ESOP that holds employer securities that are not readily tradable on an established securities market must follow specific guidelines for annual asset valuation. The valuation requires the use of an independent auditor who observes the requirements of Rev. Rul. 59-60.

 

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Like plans for lump sums

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“My client has a 401(k)/profit sharing plan and a defined benefit plan at work. He wants to take advantage of the special tax treatment for net unrealized appreciation (NUA) in employer stock that is part of a lump sum distribution. For this purpose, does he have to withdrawal the balances from both plans in order to have a true lump sum distribution?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from New Jersey is representative of a common inquiry related to the definition of lump sum distribution for special tax purposes.

Highlights of the Discussion

No; in order to meet the definition of lump sum, the IRS requires that only “like plans” of the same employer be combined when determining whether the participant’s entire balance has been paid out within one taxable year. A pension plan and 401(k)/profit sharing plan are not considered like plans in this case.

The term ‘‘lump-sum distribution’’ means payment within one taxable year of the balance to the credit of an employee that becomes payable as a result of an employee’s death, attainment of age 59 ½, separation from service, or disability. The IRS clarifies in IRC Sec. 402(d)(4)(D)(ii)(I) that “balance to the credit” means all pension plans maintained by the same employer are grouped together and treated as a single plan; all profit-sharing plans maintained by the same employer are grouped together and treated as a single plan; and all stock bonus plans maintained by the same employer are grouped together and treated as a single plan.

Conclusion

Although defined benefit pension plans and profit sharing plans are both types of qualified retirement plans under IRC. Sec. 401(a), they are not considered like plans for the purpose of taking a lump sum distribution.

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Can NUA in employer stock count towards an RMD?

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“Can the portion of a distribution from a 401(k) plan that takes advantage of NUA tax treatment be used to satisfy the receiving participant’s RMD for the year?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.  We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with an advisor in Colorado is representative of a common inquiry involving net unrealized appreciation (NUA) and required minimum distributions (RMDs).

Highlights of discussion

  • Yes— amounts excluded from income at the point of distribution, such as NUA on employer securities, are amounts a plan participant may count toward satisfying an RMD under Internal Revenue Code Section (IRC §) 401(a)(9). (NUA is eventually included in the participant’s income as taxable long-term capital gains when the employer securities are eventually sold.)
  • According to Treas. Reg. 1.401(a)(9)-5, Q&A 9, with a few, limited exceptions, all amounts distributed from a qualified plan are amounts that are taken into account in determining whether an RMD is satisfied for a participant, regardless of whether the amount is includible in income.
  • For example, amounts that are excluded from income as recovery of “investment in the contract under IRC§ 72” (i.e., after-tax contributions) are taken into account for purposes of determining whether an RMD is satisfied for a year. Similarly, amounts excluded from income as NUA on employer securities are counted towards satisfying an RMD of the participant.
  • The following amounts are not taken into account in determining whether a participant’s RMD is satisfied for the year:
  1. Amounts returned to a participant to correct plan excesses;
  2. Loans treated as deemed distributions;
  3. The cost of life insurance coverage (i.e., PS 58 costs);
  4. Dividends on employer securities; and
  5. Other similar amounts as deemed by the IRS and published in the Internal Revenue Bulletin from time to time.

Conclusion                                                   

The IRS is clear that NUA on employer securities is a distribution amount that a plan participant may count toward satisfying his or her RMD for the year.

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golden eggs
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Decrease in Employer Stock Value

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“I’m familiar with employer stock and the special tax treatment for net unrealized appreciation (NUA), but what happens if the employer’s stock decreases in value?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of discussion

  • When distributed from the plan, if the value of the employer’s stock has decreased in value to an amount that is less than the plan participant’s cost basis (attributable to the participant’s after-tax contributions) in the shares, he or she may be able to claim a loss under Internal Revenue Code 165—but not until the year the stock is sold. For additional information, please see IRS Revenue Ruling 72-305. In order to claim the loss, the recipient would need to itemized deductions on his or her tax return.

 

  • There is an exception to the above rule in cases where the stock becomes worthless as a result of the employer’s bankruptcy.  A participant who receives a distribution of worthless stock of a bankrupt employer is entitled to an ordinary loss deduction in the year of the distribution for the total amount of his or her after-tax contributions used to purchase the stock.  For additional information, please see IRS Revenue Ruling 72-328.

Conclusion

Investing in employer stock within a qualified plan can subject the investor to losses, and so should be carefully considered before undertaking.  There are limited circumstances under which a plan participant may claim a loss in value to employer stocks distributed from a qualified retirement plan.

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