Tax Relief by Rolling Your ESOP Stock into your IRA
Once you retire, you may decide to roll-over your business-related qualified plan holdings into an Individual retirement arrangement (IRA). You obtained a tax relief for the contribution to those company plans, therefore you will pay ordinary income tax rates when you withdraw them from your IRA.
In the event you purchased your company’s stock via an Employee Stock Ownership Plan (ESOP), through your 401(k) or other qualified retirement plan, and the stock has appreciated, you can pay lowered taxes on it if you don’t roll it over into an IRA. Here’s how the tax relief works.
Request that the shares of your employer’s stock be dispersed to you rather than combined with the other assets that get rolled over. You will be needed to pay tax on the dollar amount you contributed to originally buy the shares within the qualified plan (or on the amount your employer paid for the shares). That quantity is taxed at normal income rates and that ‘purchased’ amount becomes your basis in the shares for later computation of gain.
Normally, every asset in qualified plans and IRAs is taxed at ordinary rates when withdrawn but these employer shares get the special treatments of allowing you to pay ordinary tax only on the basis and capital gains on the rest of the value.
Obviously, in the event the stocks have risen considerably beyond their price to you, their market value will be higher than your tax basis. The difference between the stock’s current market worth and your tax basis is the ‘net unrealized appreciation’ (NUA). This NUA is the gain you will have in the event you sell the stock right away. If you do, you’ll be taxed on it at the lower ‘long-term’ capital gains rate no matter how long you owned that stock, because it’s treated as being held long-term. Thus, the tax relief is that you may trade what would usually be taxed as normal income (at rates as much as 35%) as capital gains (15% in 2012).
You are not required to sell the stock so you could hold on to the stock as long as you need – maybe selling off blocks of shares as cash is needed, or over a period of years, to spread out the tax burden. You’ll only pay the capital gains over and above your cost basis at the long-term capital gains rate. You may even allow beneficiaries to inherit that stock and they’ll also receive the same tax relief!
In the event you simply rolled that stock into an IRA, you’d be paying normal income tax rates as well on that part which you may apply the long-term capital gains tax rate by getting the stock directly. Therefore in the event you made that, you would be losing a tax relief – and money.