Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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2.4.06 Special averaging: Participant born before 1936 If an LSD meets certain additional requirements (no portion of the distribution may be rolled over, etc; see Form 4972), the LSD can be taxed separately, using the “10-year averaging” and/or “20 percent capital gain” methods. These two special tax deals are referred to collectively as the “ special averaging method .” An LSD for which a proper election is made to use these methods is excluded from the recipient’s adjusted gross income (AGI), and is instead taxed using special rates. § 402(d)(3) ; § 62(a)(8) . These Code sections have been repealed for years after 1999, but still apply under the “transition rule” that “grandfathers” participants born before 1936; see effective dates for amendments to § 62 and § 402 . The special averaging method is available only for individuals “who attained age 50 before 1 - 1 - 86.” TRA ’86 § 1122(h)(3), (5), (6), as amended by TAMRA ’88, § 1011A(b), (13)–(15). The IRS variously interprets this as applying to anyone born before January 2, 1936 (see IRS Form 4972 (2009), lines 3–4), or before January 1, 1936 (see Notice 2009-68, 2009-39 IRB 423, p. 429). For more information regarding this grandfather rule, see Instructions for IRS Form 4972, and the Special Report: Ancient History ( Appendix C ). 2.5 Net Unrealized Appreciation of Employer Stock This ¶ 2.5 describes the special favorable tax treatment available for “lump sum distributions” (and certain other distributions) of employer stock from a retirement plan. For definition of lump sum distribution, see ¶ 2.4.02 – ¶ 2.4.05 . For Roth conversion of NUA stock, see The Code gives special favorable treatment to distributions of employer securities (referred to here as “employer stock,” though the “securities” could be stocks or bonds; § 402(e)(4)(E) ) from a qualified plan. Some plans hold the employer securities inside some type of “single-stock fund” rather than directly; you may need an opinion of the plan’s or other counsel regarding whether the particular securities held in your client’s plan constitute “employer securities.” “ Net unrealized appreciation” (NUA) is the excess of the stock’s fair market value at the time of distribution over the plan’s basis in the stock. Reg. § 1.402(a)-1(b)(2) . If various requirements are met:  The NUA is excluded from the employee’s gross income at the time the securities are distributed to the employee. § 402(e)(4)(A) , (B) . Accordingly, the employee is liable for income tax (and 10% early-distribution penalty, if applicable; ¶ 9.1.03 (A)) only on the plan’s basis in the stock.  When the stock is later sold, the NUA is taxed as long-term capital gain, regardless of how long the recipient (or the plan) held the stock. Reg. § 1.402(a)-1(b)(1)(i) ; Notice 98-24, 1998-1 C.B. 929; PLR 2004-10023. The sale proceeds attributable to the NUA and any post-distribution gain are not subject to the early-distribution penalty. ¶ 9.1.03 (A). Joe Example: Joe, age 53, retires from Baby Bell Corp. in 2009 and receives an LSD of his 401(k) plan, consisting entirely of 10,000 shares of Baby Bell stock. The plan’s basis for that stock is $10 ¶ 5.4.04 (A). For charitable gifts of NUA stock, see ¶ 7.6.04 . 2.5.01 NUA: Tax deferral and long-term capital gain