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Know What To Do with Your Appreciated Company Stock.
Before you take your stock from your previous employer and roll it into an IRA, or drop it on a ’72 Camaro, consider the little-known tax break—net unrealized appreciation, or NUA. This overlooked option may prove to be the difference in a sizable amount of capital. Taking the time to research it is definitely worth it. And unlike the Camaro, this research won’t depreciate the moment it hits your driveway.
The NUA tax break differs from the IRA rollover in that the NUA stock is transferred to a taxable account, where the initial tax is due at the time of the transfer. IRAs are taxed at income tax rates only when they are withdrawn, whereas the NUA tax break is taxed on the original cost of the shares at time of transfer, not the current market value.
Keep in mind that although transferred NUA stock is not in an IRA, early distributions are still subject to a 10% tax penalty (bad), but the tax on the time that your stock is sold is not based on income tax rates but on the maximum capital gains rate, currently 20% (good!).
Changes from last year’s American Taxpayer Relief Act add another wrinkle to considering an NUA strategy. The issue is that withdrawals from IRAs are not directly subject to the new 3.8% Medicare surtax – they’re not treated as net investment income – while the gains from NUA are potentially subject to the tax. Previously the opportunity was to trade a maximum ordinary income rate of 35% for a 15% long-term capital gains rate (a difference of 20%), this year it’s a top 39.6% ordinary rate versus a 23.8% maximum capital gains rate (a difference of only 15.8%). The spread still remains, so there could still be value, but it is smaller.
Qualifying for the NUA tax break is somewhat complicated: the entire plan balance must be withdrawn all together in one tax year, though the balance of the account (assets other than the company stock) can be rolled over into an IRA. And even if you do qualify, it is critical to consider if it is right for you. Typically, taking full advantage of the NUA tax break means that you are in a high tax bracket and your company stock is a strong candidate for appreciation makes up a significant proportion of your retirement account when it has appreciated.
As in any investment strategy, diversification should be closely considered. Keeping NUA company stock in a taxable portfolio runs the risk that you become too concentrated in one position – effectively putting all of your eggs in one basket. If stock is rolled into an IRA, you can sell the position and diversify the portfolio with no tax consequences until distributions are taken in the future.
Ultimately, the NUA tax break is not for everyone, but it is worth the initial research. Consult a tax professional before you make any decision on what to do with your company stock. But also, be honest with yourself: Have you defined the best case scenario of that particular stock in the short-term vs. the long-term? Understanding your own needs, and knowing which tax bracket you fall into empowers you to know what to do with your company stock, and if this NUA tax break is worth it. No matter the outcome, you will be glad you took the time to make a wise move with what may be your largest retirement asset.