Discussion:NET UNREALIZED APPRECIATION (NUA) TAX QUESTIONS

NET UNREALIZED APPRECIATION (NUA) TAX QUESTIONS

Employee takes Lump-Sum Distribution of Company Stock, pays ordinary income tax on Original Basis and defers tax on NUA.

Employee dies still owning Company Stock which is included in his Taxable Estate at FMV at Date of Death.

Non-spousal Beneficiary #1 inherits stock with a basis decreased due to previously untaxed NUA.

When Beneficiary #1 sells inherited stock, he or she pays Capital Gains Tax on previously untaxed UNA.

Questions –

Is Beneficiary #1 “forced” to sell the stock during his or her lifetime?

Can he or she leave the stock to Beneficiary #2 in his or her will?

If he or she does not sell any of the stock, does he or she pay income or capital gains tax on the previously untaxed NUA at time of his or her death?

Does Beneficiary #2 receive a step-up in basis to the FMV of the stock on the Date of Death of Beneficiary #1?

Does the previously untaxed NUA carryover to Beneficiary #2 through a decreased basis or other means?

If Beneficiary #2 never sells the stock, does the previously untaxed NUA carryover to succeeding owners of the stock?

Is the sale of the stock the only triggering event for the taxation of the previously untaxed NUA?

If the stock is never sold and becomes worthless, is the previously untaxed NUA ever subject to tax (Capital Gain or Ordinary)?

Is the “future” Capital Gains Tax on the UNA left in the Employee’s estate considered a debt of the decedent and deductible on Schedule K or elsewhere on Employee’s Form 706?

Just spoke to associate regarding this. The NUA was generated from employee/employer match of purchased stock placed in a retirement plan. GE is big in this area, so I use them as an example. 1000 shares of GE were placed in the plan over time and let's say the basis was $5 a share, so original basis was $50,000. Employee is retiring from company 30 years later. GE Stock is $15 a share so the value is $150,00 <$50,000 basis plus $100,000 NUA>. Employee has the option of rolling this over into a IRA or to take a 100% lump sum distribution and pay ordinary income tax on the original basis value <$50,000>. The NUA would get taxed when he sold it <presumably at a lower capital gains tax vs the ordinary income if he rolled it over>.

I think the issue with the stepped up basis is the fact that it accrued within the pension plan. Let's say Employee dies a year later when the stock is valued at $170,000. The beneficiary would get the $50,000 basis plus the $20,000 increase in FMV.

My associate is saying that the NUA of $100,000, because it was within the pension plan, is not eligible for the step up in basis.

I don't know if this is true or not. He is pretty confident it is. Naturally, if this was stock purchased directly by any of us, beneficiaries would get the stepped up basis.

But, if you take out the transfer to beneficiaries scenario, you can see how for high net worth clients, taking the lump sum distribution on highly appreciated stock plans can create tax savings vs the rollover.

I am not an NUI expert - so I'd like to see the answer to your question as well.

Must be something to do with IRD.

NUA IS IRD

If Ed Slott says it, I believe it.

In reading link 1, it explains it the way my associate explained it to me, which is they NUA follows to the beneficiary, except for the excerpt below which I pulled out. this confused, me/seemed contradictory. On one hand, it says the NUA flows, but the excerpt below reads to me like the NUA is taxed immediately upon the death of the owner, that the beneficiary must pay the tax on the NUA, less estate taxes attributed. Am I reading it wrong?

If the shares distributed from the qualified plan are not sold during the life of the individual, the amount of the NUA will be treated as income in respect of a decedent (IRD). Under IRC section 691(a)(1), an amount is considered IRD if the decedent was entitled to the income at the time of death, but such income was not properly includable in income in the year of the individual's death or a prior period. IRD is included in the taxable income of the person who receives it by reason of the decedent's death. There is an income tax deduction available to the recipient for the estate tax paid on the IRD.

The Estate Planning Considerations section of this document http://spwfe.fpanet.org:10005/public/Unclassified%20Records/FPA%20Journal%20February%202004%20-%20Contribution_%20Revisiting%20Net%20Unrealized%20Appreciation_%20A%20Tax-Wi.pdf agrees with your associate as to the NUA not being eligible for the step up in basis, and is taxable at time of sale by beneficiaries at long term capital gains tax.

This site http://www.smithbarney.com/products_services/planning_services/retirement_planning/pdf/nua.pdf says essentially the same thing in its example under Leaving Company Shares to Your Beneficiaries. As you noted in the 1 link above this post seems to imply the tax on the NUA is due at death paid by beneficiary, but the example clarifies only due on sale of stock.

I've scanned section 1.691(a)-1 of the regulations and accepting for the moment they apply, which is the premise of your original post, the answers are as follows:

Beneficiary #1 never "forced" to sell stock. ( This is still America)

Beneficiary #1 can leave the stock to beneficiary #2 in his will.

He does not pay tax at the time of his death on NUA basis.

Beneficiary #2 does receive a step up in basis to FMV, less NUA carryover amount. So all appreciation from reciept by Ben 1 till receipt by Ben 2 = tax free step up. As support I offer the following from section 1.691(a)-1 of the regulations http://edocket.access.gpo.gov/cfr_2009/aprqtr/pdf/26cfr1.691(a)-1.pdf

"(c) Prior decedent. The term income in respect of a decedent also includes the amount of all items of gross income in respect of a prior decedent, if (1) the right to receive such amount was acquired by the decedent by reason of the death of the prior decedent or by bequest, devise, or inheritance from the prior decedent and if (2) the amount of gross income in respect of the prior decedent was not properly includible in computing the decedent’s taxable income for the taxable year ending with the date of his death or for a previous taxable year. See example 2 of paragraph (b) of § 1.691(a)–2."

Also look at example 3 of paragraph (b) of 1.691(a)-2 for an illustration of IRD being recognized at the time of the ultimate taxable transaction rather than at the time of death of the decedent.

Which means the NUA is carried over and continues to limit step-up to FMV for all future transfers from decedents to beneficiaries.

The sale or any other "taxable transfer" would trigger the capital gains tax associated with the NUA.

If the stock becomes worthless no capital gain to recognize and NUA dissapears.

Don't know the answer to the last question regarding the "future" capital gains tax considered a debt of the descedent, though would guess no. Do know that a deduction is available to the beneficiaries for estate taxes paid on the value of the NUA included in the decedents estate, per section 1.691(c)-1 of the regulations http://edocket.access.gpo.gov/cfr_2009/aprqtr/pdf/26cfr1.691(c)-1.pdf

"(a) In general. A person who is required to include in gross income for any taxable year an amount of income in respect of a decedent may deduct for the same taxable year that portion of the estate tax imposed upon the decedent’s estate which is attributable to the inclusion in the decedent’s estate of the right to receive such amount."