Subject:   You’ve got some excellent information
Date:   Fri, 31 Aug 2001
From:   Eva Rosenberg (for a visitor to her website)

Hi. I left my former employer to start my own business about two years ago. I have shares I accumulated as part of the company ESOP. I would like to have the ESOP shares distributed in-kind to my current brokerage account. However, I am wary of the tax consequence. What would the percentage tax likely be on the distribution of the shares as well as the earnings on the subsequent sell of the shares. Thanks!

Best wishes Eva Rosenberg, MBA, EA
Taxmama.com Where taxes are fun!

Answer

Date:   Fri, 7 Sep 2001

Hello Eva,

You haven’t really provided enough information for me to give you a complete answer. Please consider meeting with a professional tax advisor to get personalized help for your situation.

Here are a few things to think about.

1. Under Internal Revenue Code Section 402(e)(4)(B), in order to avoid a current tax for the appreciation on the employer securities, they must be distributed during one tax year as part of a lump-sum distribution. Under Internal Revenue Code Section 402(e)(4)(D), a distribution on account of the employee’s separation from service qualifies, provided you completed at least five years of service with your employer. (Internal Revenue Code Section 402(d)(4)(F).) The distribution must include all employer securities credited to the employee’s account.
2. Appreciation relating to securities purchased using the employee’s non-deductible contributions to an ESOP qualifies for deferral even if the distribution doesn’t qualify as a lump-sum distribution. (Internal Revenue Code Section 402(e)(4)(A)).
3. You are taxed as ordinary income for the amount the ESOP paid for the shares. In order to determine the tax rate that applies, you need to add the distribution to your other taxable income and look it up on a tax rate schedule.
4. The tax basis for each share received is the fair market value at the date of distribution, minus the unrealized appreciation that was not taxed on the distribution, divided by the number of shares received. (Revenue Ruling 74-398.)
5. When the securities are sold, the gain up to the untaxed unrealized appreciation on the date of distribution is taxed as a long-term capital gain. Whether any additional gain is taxed as a long-term or short-term capital gain depends on how long the stock was held after distribution. (Treasury Regulations Section 1.402(a)-1(b)(1)(i).)
6. You may roll over any cash you receive and hold onto the employer securities to defer the tax for the cash received. (Letter Rulings 9721036 and 199928034.)
7. There is a 10% additional tax for early distributions from retirement accounts. The penalty generally applies to taxable amounts distributed before the taxpayer is age 59 ½. (Internal Revenue Code Section 72(t)(2)(A)(i).) There is an exception when the distribution is made from an employer plan because of a separation from service provided the separation happened during or after the calendar year in which the participant reached age 55. (Internal Revenue Code Section 72(t)(3)(A).) (Distributions from IRAs don’t qualify for this exception.)

The plan administrator for the ESOP should be able to give you some information about the details for your distribution.

I hope this helps!

Mike Gray

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