Net Unrealized Appreciation

Key Takeaway

Net Unrealized Appreciation (NUA) is a term referencing the growth of employer stock while held in an Employee Stock Ownership Plan (ESOP). Mathematically, it is the difference between the cost basis of the stock when the ESOP acquired it and the market value at the time it is distributed. This appreciation (plus any market fluctuations after the stock leaves the ESOP) can be taxed at capital gain tax rates instead of ordinary income tax rates when certain requirements are met. Since capital gain tax rates can be significantly lower than those on ordinary income, electing to take the stock as an in-kind taxable distribution may create some additional talking points as you contemplate your distribution options.

Requirements to qualify for special tax on employer stock:

  1. 1

    The entire ESOP account balance must be distributed as a lump sum by the taxpayer’s tax year end (December 31 for most).

  2. 2

    The employer stock must be distributed in-kind to the account holder as a taxable event. Cash or other investments can be rolled over to avoid immediate taxation.

  3. 3

    The distribution must be the result of a triggering event as defined by the ESOP document. Although the ESOP administrator/sponsor will make all final decisions on what qualifies as a triggering event, examples of a triggering event include termination of employment, death, disability, or reaching age 59½. Please note that in-service distributions generally do not qualify as a triggering event.

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For example, in the illustration above, if the participant chooses to rollover the Cash and Other Investments, elects to take the stock in-kind as a taxable event, and meets all the other requirements above, the cost basis of the employer stock will be taxable as ordinary income in the year of distribution. If the participant sells any stock, the NUA on that stock will usually be taxed as long-term gain, while any market appreciation/depreciation on the stock since being distributed from the ESOP will be taxed as short/long-term gain/loss depending on the holding period from the distribution date to the selling date.

Determining whether your ESOP provisions make you eligible for the special tax treatment is best handled by working with the plan administrator/sponsor while determining whether the special tax treatment will benefit you and will involve your tax preparer. Alerus can help navigate these discussions as well as help set up the desired investment accounts.