ALAN S. MOORE

Rolling company stock into an IRA can be taxing It is a less than well-publicized fact that employees leaving a job with a large amount of company stock in their retirement plan can take advantage of some significant tax advantages provided they don’t roll that stock into an IRA. Many financial advisors only discuss the tax ramifications of not rolling a retirement plan distribution into an IRA in a negative sense. The tax advantages of walking away with a former employer’s company stock certificate are either ignored or unknown. As more and more companies downsize and former employees are faced with the options regarding a retirement plan distribution, it is important to be aware of the advantages and disadvantages attached to rolling over company stock. When an employee elects to take a distribution upon termination of employment, a company must offer the options of receiving the distribution in cash or securities, or rolling it into an IRA. If the employee elects to receive the assets, there may be a 10 percent penalty, 20 percent withholding, and the employee will owe income taxes on that portion of the distribution which does not represent after-tax contributions (generally 100 percent is taxable). Rolling the distribution into a rollover IRA is therefore usually the more attractive option, however if the employee has a large amount of highly appreciated company stock in the retirement account, not rolling the company stock could mean a significant savings by deferring the tax on the appreciation. When taking receipt of company stock, the employee will owe taxes, but only on the value of the shares at the time the stock was purchased or when the company issued the stock to the employee’s account (the “cost basis”). If the company’s stock is a winner, this cost basis is usually much less than the stock’s current selling price. Any applicable 10 percent premature penalty and 20 percent withholding will only apply to this cost basis, as opposed to the current value. The employee will, of course, pay annual income taxes on any dividends. The employee can continue to defer taxes on all of the appreciation that has occurred since the time of initial purchase until the shares are sold, at which point taxes will be paid on the unrealized appreciation at date of distribution at the long-term capital gains rate and not at the often higher income tax rates. With respect to any further appreciation after distribution, the distributee’s actual holding period determines the capital gains rate that will apply. If the employee dies after receiving the distribution, the heirs will receive all appreciation tax-free because they will receive a “step-up” in basis. If, however, the employee elects to roll shares of company stock into an IRA, he/she will pay ordinary income tax rates on any subsequent withdrawals from the IRA, and if the employee dies leaving shares in the account, the heirs will owe ordinary income tax on the entire value of the stock. On the other hand, rolling over company stock into an IRA will allow the employee to diversify his/her position immediately without any tax consequences. The biggest potential tax benefit of owning employer stock comes to the employee who made after-tax contributions to a retirement plan in addition to saving the usual pretax amounts. Any after-tax contributions are distributed from the account tax free; if instead of receiving that distribution in cash the employee elects to receive it in company stock, the stock will be valued at basis, and the entire amount will be received tax-free. So if for example, an employee has $5,000 in after-tax dollars in a retirement account, he can withdraw company stock with a basis of $5,000 tax-free, even though the current market value of the stock may be $20,000. Be sure to contact your tax advisor regarding potential penalties and withholding as they may pertain to your personal situation. ALAN S. MOORE is a Financial Advisor of Legg Mason Wood Walker, Inc., a diversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc. and SIPC.