Author: Leon Clinton

Do you own any of your employer’s company stock inside your employer’s 401(k), ESOP, profit sharing plan, or other retirement plan? 

Has it gone up in value since you got it? If so, you should start thinking about what to do with the stock when you retire or leave your employer. Your decision can have big tax consequences.

Most people roll company stock into an IRA when they retire or leave. When you do this, no tax is due. 

But there’s a downside: when you later sell the stock, you’ll have to pay tax on the proceeds at ordinary income tax rates, which can be as high as 37 percent (and could be going higher).

You have another alternative: electing net unrealized appreciation (NUA) treatment for your company stock. This way, whenever you sell the stock, you pay tax on your NUA at long-term capital gains rates, which are 15 percent for most people. 

The tradeoff: you have to pay tax on your tax basis in the stock at ordinary income rates for the year you transfer it. You may also have to pay the 10 percent early withdrawal penalty on your shares’ cost basis if you take your lump-sum distribution before reaching age 59 1/2. 

Any additional appreciation in the stock at the time of sale also receives capital gains treatment—it will be taxed at the long-term capital gains rate if you hold the stock for more than one year from the distribution date.

To qualify for NUA treatment, you must transfer all your vested employer retirement plan assets as part of a lump-sum distribution made after you reach age 59 1/2, leave your employer, or die.

Because the stock is not in a retirement plan, it is not subject to the required minimum distribution rules. You can keep it in your account until you die. Your heirs then get a stepped-up basis above the NUA amount for the appreciation in the stock during the time you held it in your taxable account.

Net unrealized appreciation treatment isn’t for everyone. It works best for older employees who have substantial appreciation in their company stock and want the money soon while paying the lowest taxes.

If you have any questions or need my assistance with this or any matter, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 5, 2021

As a business owner, you are in partnership with the IRS, like it or not.

You share your net profits with the IRS according to your partnership agreement (known to you as the Internal Revenue Code).

To make sure you are sharing fairly, the IRS can audit your tax return. You have to hate the idea of an IRS audit.

But your big audit worry is not about the potential bills for unpaid taxes, interest, and penalties. No, your big worry is the additional time the audit will take.

Tax audits can go on for months or even years. Time and resources spent preparing for and participating in an IRS audit are time and resources that are not available for you to run your business.

So, you should consider two things here:

1. How can you spend less time in an IRS audit?
2. How can you pay the IRS nothing extra, or at least as little as possible, in an audit?

You need to get ready for the audit every day, because you are in business. The major chunk of records you need for the audit are the records that help you run your business.

Keeping the minor additional records you need to prove certain tax deductions for your vehicles, entertainment, and travel takes only minutes a day.

Planning point. Keep good records every day.

If you would like my help with your records, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 1, 2021

Here’s good news. IRS regulations allow you to claim a prorated (reduced) gain exclusion—a percentage of the $250,000 or $500,000 exclusion in select circumstances.

The prorated gain exclusion equals the full $250,000 or $500,000 figure (whichever would otherwise apply) multiplied by a fraction. 

The numerator is the shorter of 

• the aggregate period of time you owned and used the property as your principal residence during the five-year period ending on the sale date, or 
• the period between the last sale for which you claimed an exclusion and the sale date for the home currently being sold. 

The denominator is two years, or the equivalent in months or days.  

When you qualify for the prorated exclusion, it might be big enough to shelter the entire gain from making a premature sale. But the prorated exclusion loophole is available only when your premature sale is due primarily to

• a change in place of employment, 
• health reasons, or 
• specified unforeseen circumstances.

Example. You’re a married joint-filer. You’ve owned and used a home as your principal residence for 11 months. Assuming you qualify under one of the conditions listed above, your prorated joint gain exclusion is $229,167 ($500,000 × 11/24). Hopefully that will be enough to avoid any federal income tax hit from the sale.

Premature Sale Due to Employment Change 

Per IRS regulations, you’re eligible for the prorated gain exclusion privilege whenever a premature home sale is primarily due to a change in place of employment for any qualified individual.

“Qualified individual” means

1. the taxpayer (that would be you), 
2. the taxpayer’s spouse, 
3. any co-owner of the home, or 
4. any person whose principal residence is within the taxpayer’s household.

In addition, almost any close relative of a person listed above also counts as a qualified individual. And any descendent of the taxpayer’s grandparent (such as a first cousin) also counts as a qualified individual.  

A premature sale is automatically considered to be primarily due to a change in place of employment if any qualified individual passes the following distance test: the distance between the new place of employment/self-employment and the former residence (the property that is being sold) is at least 50 miles more than the distance between the former place of employment/self-employment and the former residence.

Premature Sale Due to Health Reasons

Per IRS regulations, you are also eligible for the prorated gain exclusion privilege whenever a premature sale is primarily due to health reasons. You pass this test if your move is to 

• obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or 
• obtain or provide medical or personal care for a qualified individual who suffers from a disease, an illness, or an injury. 

A premature sale is automatically considered to be primarily for health reasons whenever a doctor recommends a change of residence for reasons of a qualified individual’s health (meaning to obtain, provide, or facilitate care, as explained above). If you fail the automatic qualification, your facts and circumstances must indicate that the premature sale was primarily for reasons of a qualified individual’s health. 

You cannot claim a prorated gain exclusion for a premature sale that is merely beneficial to the general health or well-being of a qualified individual. 

Premature Sale Due to Other Unforeseen Circumstances

Per IRS regulations, a premature sale is generally considered to be due to unforeseen circumstances if the primary reason for the sale is the occurrence of an event that you could not have reasonably anticipated before purchasing and occupying the residence. 

But a premature sale that is primarily due to a preference for a difference residence or an improvement in financial circumstances will not be considered due to unforeseen circumstances, unless the safe-harbor rule applies. 

Under the safe-harbor rule, a premature sale is deemed to be due to unforeseen circumstances if any of the following events occur during your ownership and use of the property as your principal residence:

• Involuntary conversion of the residence 
• A natural or man-made disaster or acts of war or terrorism resulting in a casualty to the residence
• Death of a qualified individual
• A qualified individual’s cessation of employment, making him or her eligible for unemployment compensation
• A qualified individual’s change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household
• A qualified individual’s divorce or legal separation under a decree of divorce or separate maintenance
• Multiple births resulting from a single pregnancy of a qualified individual

If you are looking at a need for the prorated home-sale gain exclusion and would like my help, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 29, 2021