Planning for distributions of employer securities.

• Author: Ellentuck, Albert B.

Favorable tax rules apply when a lump-sum distribution (LSD), as defined in Sec. 402(e)(4)(D), is composed in whole or in part of securities of the employer corporation. Under Sec. 402(a) and (e)(4)(B), employees are not taxed on the net unrealized appreciation (NUA) when the securities are distributed; in other words, on distribution, the employees are not taxed on the securities' full fair market value (FMV). NUA is defined as the excess of the aggregate FMV of the securities on the distribution date over the aggregate cost or other basis of such securities to the plan.

Tax Treatment

The NUA in an LSD of employer securities is excluded from the recipient's gross income under Sec. 402(e) (4) (B). The NUA can be excluded from income even if the employee receiving the distribution has not been a plan participant for five years. The amount included in income by the recipient (i.e., FMV less NUA) is taxed under the LSD rules (Sec. 402(e)(4)(D)).The employee's share of the plan's basis in the employer securities distributed is the amount included in gross income. If the distribution is not part of an LSD, the NUA excluded from the recipient's gross income includes only the amount attributable to nondeductible employee contributions. The NUA attributable to deductible voluntary employee contributions is taxable; see Sec. 402(e)(4)(A) and Szilagyi, TC Memo 1982-656.

When employer securities are sold after distribution, any gain realized is long-term capital gain subject to a maximum 15% rate, to the extent attributable to NUA not taxed at the time of receipt of the securities. The long-term or short-term status of any capital gain in excess of this amount depends on how long the distributee actually holds the securities after distribution from the plan; see Notice 98-24 and Regs. Sec. 1.402(a)-1(b)(1)(i)(b). For this purpose, the employee's holding period in the securities begins on the day after the date they are delivered to the transfer agent with instructions to reissue the stock in the employee's name; see Rev. Rul. 82-75 and Letter Ruling 8724049.

Rolling over Appreciated Employer Stock

Distributions of employer securities can be rolled over to an eligible retirement plan whether or not they are distributed in an LSD. However, retaining direct ownership of appreciated employer stock received in an LSD (instead of rolling over to an eligible retirement plan) provides the following tax advantages:

1. The employee is taxed only on the shares'...