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If you paid any benefit payments last year, then you will have to prepare and file some government forms. The General Instructions for Forms 1099, 1098, 5498, and W-2G provides guidance on how to prepare and file the forms.

  • IRS Forms 1099-R – This form must be provided to anyone who received a plan distribution (of $10 or more) during the calendar year. The participants' copies must be mailed by January 31. Copies must be filed with the IRS by February 28 (or March 31 if filing the forms electronically).
  • IRS Form 1096 – This form must be sent as a transmittal document whenever paper copies of the IRS Forms 1099-R are sent to the IRS. If they are submitted electronically, then this form is not required.
  • IRS Form 945 – This form is used to report federal withholding from non-payroll payments, including distributions from qualified retirement plans. The deadline is January 31. This year's Form 945 is due by January 31, 2008. However, if you made deposits on time in full payment of the taxes for the year, you may file the return by February 12, 2008.

Generally, you are required to file electronically or by magnetic media if you file 250 or more information returns.

As you are preparing the IRS Forms 1099-R, you may be processing some forms for participants that received lump sum distributions that may qualify for NUA treatment.

What is Net Unrealized Appreciation (NUA)?

Net Unrealized Appreciation (NUA) is the appreciation of company stock held in a qualified retirement plan.

What are the benefits of NUA?

IRC Section Sec. 402(e)(4) - Taxability of beneficiary of employees' trust - Other rules applicable to exempt trusts - Net unrealized appreciation provides special tax benefits for the distribution of company stock from a qualified retirement plan if certain requirements are met. Only the original cost basis of the company stock is taxed at ordinary income rates. The NUA is taxed at long-term capital gains rates at the time the company stock is sold (which is usually immediately for privately held ESOPs). Any additional appreciation after the distribution from the qualified plan to the time the company stock is sold is taxed using the long-term or short-term capital gains rates, depending on the holding period. In addition, any applicable 10% early withdrawal penalty is only applied towards the cost basis and not the NUA.

What requirements must be met to take advantage of the tax benefits?

Generally, a participant must take an in-kind lump sum distribution (within one tax year) directly from the plan. Please see the above-mentioned code section for more details.

How are distributions that qualify for NUA treatment reported on IRS Form 1099-R?

Here is a sample IRS 1099-R for your reference: 2007 Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Assuming a distribution qualifies for NUA treatment, the amounts would generally be recorded as follows:

  • Box 1 – Gross distribution – This amount will be equal to the fair market value of the shares plus and cash distributed.
  • Box 2a – Taxable amount – This amount will be equal to the cost basis of the shares and any cash distributed.
  • Box 6 - Net unrealized appreciation in employer's securities – This amount will be equal to the difference between the cost basis and the fair market value of the shares.

When should NUA be used and when shouldn't it be used?

This article
evaluates the benefits of using NUA and provides examples. The article considered the following factors in making a NUA decision:

  1. Tax rates
  2. Absolute NUA
  3. Ratio of the NUA to the FMV of the company stock
  4. Time Horizon

The article also discussed a model prepared to help evaluate the different distribution options. Based on the assumptions of the model, for short holding periods, electing NUA and immediately selling the stock and reinvesting it in a diversified equity portfolio was the best choice. For longer holding periods, not electing NUA and rolling the sale proceeds into an IRA, reinvesting them in a diversified equity portfolio was the best choice. Due to the high volatility of company stock, holding the company stock after distribution was never the best choice. The article also discussed the possibility of identifying specific shares of company stock to sell to maximize the NUA treatment while minimizing the amount required to be distribution directly to the participant.

Additional Information

This post contains another NUA discussion NUA – A Great Tax Benefit, and Lots of company stock in your 401(k)? Better learn about NUA (net unrealized appreciation) is another NUA-related article.

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