NUA Election: $300K Company Stock Math at Termination

Net Unrealized Appreciation under IRC 402(e)(4) is one of the most generous tax breaks in the retirement-plan code - and one of the easiest to surrender by accident. The election applies to employer securities held inside a 401(k), ESOP, or similar qualified plan. When the plan distributes those shares to you in-kind as part of a qualified lump-sum distribution, you pay ordinary income tax only on the plan's cost basis (typically what the plan paid for the shares or what was reported on your W-2 when ESOP shares were allocated). The appreciation - the NUA - is deferred and ultimately taxed at long-term capital gains rates when you sell the shares. For employees with substantial appreciated company stock at termination, the federal tax savings vs. a standard rollover routinely reach $30,000 to $80,000 on positions of $200K to $500K.

The three-tier NUA tax treatment

Once you make the NUA election and receive the stock in-kind, the position has three distinct tax pools, each with its own rate and timing:

• Tier 1: Cost basis. Taxed as ordinary income in the year of distribution. This is the plan's basis in the shares - generally the price paid for shares acquired through purchase, employer matching contributions, or ESOP allocations. The 1099-R issued by the plan administrator reports this basis in Box 6 as "Net unrealized appreciation in employer's securities" - the box label is misleading because it labels the basis subtraction; the actual NUA is the difference between Box 1 (gross distribution) and Box 6.
• Tier 2: Net Unrealized Appreciation (NUA). The difference between the shares' fair market value at distribution and the cost basis. Not taxed at distribution. When you sell the shares - whether the next day or 30 years later - the NUA portion is taxed as long-term capital gain at 0, 15, or 20 percent depending on your taxable income that year, plus 3.8 percent NIIT if your MAGI exceeds the thresholds ($200K single, $250K MFJ). The NUA is always LTCG, regardless of post-distribution holding period.
• Tier 3: Post-distribution appreciation. Any gain above the FMV at distribution. Holding period for this portion starts on the day after distribution. If held more than 12 months, it qualifies for LTCG. If sold within 12 months, it is short-term capital gain taxed at ordinary income rates.

The cleanest way to think about NUA: at distribution, the plan splits your position into three pools. You pay ordinary income tax on the smallest pool (basis) now. The middle pool (NUA) is permanently locked at LTCG treatment. The third pool (future appreciation) starts a new clock.

The four mandatory NUA requirements

NUA is only available if all four conditions under IRC 402(e)(4)(B) and (D) are met. Missing any one disqualifies the entire NUA on the position.

Requirement 1: Lump-sum distribution

The entire balance of the employee's accounts under all plans of the same kind (all 401(k) plans of the same employer, all ESOPs, etc.) must be distributed within a single calendar year. The distribution is treated as a single lump sum even though parts may be paid on different dates within the year. Partial distributions or distributions spread across multiple years fail the lump-sum requirement.

"Same kind of plan" matters: if you have both a 401(k) and a separate ESOP from the same employer, both must be distributed in the same calendar year for NUA to apply to either. If only the 401(k) is distributed while the ESOP remains, NUA fails for both.

Requirement 2: Qualifying triggering event

The lump-sum distribution must occur after a qualifying event: separation from service, death, disability (as defined in IRC 72(m)(7)), or attainment of age 59 1/2. In-service distributions before 59 1/2 do not qualify, even if the plan permits them. The most common qualifying event is separation from service.

Requirement 3: Employer securities

The shares must be "employer securities" as defined in IRC 402(e)(4)(E): stock of the corporation that employs the participant (or stock of a corporation in the same affiliated group under IRC 1504). Mutual funds, target-date funds, or company-stock funds that hold a mix of company stock and other assets generally do NOT qualify as employer securities. Some plans offer a "company stock fund" that holds only employer shares - these typically qualify, but verify with the plan administrator before distribution.

Requirement 4: In-kind distribution

The shares must be transferred to a taxable brokerage account as actual stock certificates or electronic share transfers - not sold inside the plan and the cash distributed. If the plan sells the stock and distributes cash, the entire amount is treated as ordinary income with no NUA available. This is the most common drafting error: the plan administrator processes the rollover paperwork without flagging the employer-stock position for in-kind transfer.

Worked example: $300K position, $60K basis, 32 percent bracket

A 58-year-old Chicago-based engineering manager is laid off after 18 years at a public company. Final 401(k) breakdown:

• Total 401(k) balance: $620K
• Target-date 2030 fund: $320K
• Employer stock: $300K (current FMV)
• Cost basis of employer stock (per 1099-R Box 6 reporting): $60K
• NUA: $240K ($300K FMV - $60K basis)
• Severance: $145K paid in February (lump sum)
• Other 2026 income: $35K of Q1 W-2 wages before separation
• Federal marginal bracket at $180K MFJ income: 22 percent. With NUA basis recognition added: pushes into 24 percent at $206,700.

Path A: Standard rollover (NUA forfeited)

• Direct rollover of full $620K to traditional IRA. $0 immediate tax.
• Sells employer stock inside IRA, reinvests in diversified portfolio.
• Future withdrawals: taxed as ordinary income at marginal rate.
• If marginal rate at withdrawal is 22 percent: $620K x 22 percent = $136,400 in federal tax across distribution years.
• If marginal rate at withdrawal is 24 percent (RMD age pushes into this bracket): $148,800.
• Total tax on the $300K employer stock portion: $66,000 to $72,000.

Path B: NUA election on full $300K employer stock

• Lump-sum distribution: full $620K processed within calendar year 2026.
• $320K target-date fund: direct rollover to traditional IRA. $0 immediate tax.
• $300K employer stock: in-kind distribution to taxable brokerage account. Ordinary income recognized on $60K basis.
• 2026 marginal tax on $60K basis recognition: $60K at 22-24 percent blended = approximately $13,800.
• NUA of $240K: deferred. No tax in 2026.
• Sells $300K position in 2028 when in a lower bracket (no W-2 income, before SS): 15 percent LTCG plus 0 percent NIIT (income below $250K MFJ threshold) on the $240K NUA = $36,000.
• Total federal tax on the employer stock portion: $13,800 (basis) + $36,000 (NUA at sale) = $49,800.
• Tax on rolled $320K (target-date fund): later, at ordinary rates - same as Path A.

Tax comparison summary

• Path A total federal tax on employer stock: $66,000 to $72,000
• Path B total federal tax on employer stock: $49,800
• Federal tax savings via NUA: $16,200 to $22,200

For Illinois residents, the savings grow because IL conforms to federal LTCG treatment but the state tax rate of 4.95 percent applies to all the gain in both paths. State tax neutral. For California residents, the savings shrink: CA does not conform to federal LTCG preferential rates and taxes all gains as ordinary income at up to 13.3 percent. NUA still saves federal tax but provides no state-level benefit.

When NUA wins big, and when it does not

NUA is not always the right answer. The breakeven analysis depends on three variables: the appreciation ratio (NUA divided by FMV), your current vs. future marginal bracket, and your post-distribution holding intent.

NUA wins clearly when:

• Appreciation ratio is greater than 60 percent. If most of the position's value is NUA (i.e., basis is small relative to FMV), the LTCG arbitrage dominates. A $400K position with $40K basis is a strong NUA candidate.
• Current marginal bracket is 24 percent or higher. The ordinary-income tax on basis is paid at your current rate, so a higher current rate makes NUA more painful. But the LTCG savings on the NUA portion are stable. If your current rate is 32 percent and your future RMD rate is also 32 percent, the savings on NUA (32 percent ordinary vs. 20 percent LTCG plus 3.8 percent NIIT) outweigh the cost of paying current ordinary income on basis - as long as the appreciation ratio is favorable.
• You plan to hold the stock long-term or to death. Holding NUA stock until death captures the partial step-up under IRC 1014 on post-distribution appreciation. The NUA portion does not step up, but the post-distribution appreciation does - meaning heirs avoid LTCG on years of additional gain.
• You have substantial non-stock retirement assets to fund early years. The basis recognition creates immediate ordinary income. If you can avoid selling the stock for several years - funding living expenses from a separate IRA, taxable savings, or Rule of 55 401(k) withdrawals - the NUA tax remains deferred.

NUA loses when:

• Appreciation ratio is below 30 percent. If basis is high relative to FMV, the ordinary income hit on basis outweighs the LTCG savings on the small NUA portion. A $200K position with $130K basis and $70K NUA is a marginal candidate at best.
• Current bracket is at 32 percent or higher AND you expect future rates to be lower. If you are at peak earnings now and will retire to a 12 percent bracket, the standard rollover defers ordinary income to the lower rate and may beat NUA.
• You plan to sell immediately and donate proceeds. Donating appreciated stock directly to a qualified charity avoids the capital gains tax entirely under IRC 170(e)(5). If your goal is charitable, the NUA stock can be donated directly from the brokerage account post-distribution - but the immediate basis-recognition ordinary income was still paid. A direct charitable rollover from the 401(k) (if available) may be more tax-efficient.
• Concentration risk dominates. If keeping $300K in a single stock represents 60+ percent of your investable assets and you must diversify, you sell the NUA stock immediately. The LTCG on $240K is paid in the same year as the ordinary income on basis. The blended rate may still favor NUA, but the diversification cost (concentration risk) is real even if tax-favorable.

Partial NUA: electing on only some of the employer stock

NUA can be elected on all or any portion of the employer securities in the lump-sum distribution. The unselected portion goes through the standard rollover treatment. The lump-sum-distribution requirement still applies: the entire 401(k) must be distributed within one calendar year.

The strategic use case for partial NUA: you have substantial current-year income (severance, accumulated bonuses, RSU vesting) and you do not want to add the full basis amount to your ordinary income in the same year. Example: $400K employer stock position with $80K basis. Taking 100 percent of the position via NUA creates an $80K ordinary income event. If your other income is already at $300K, the $80K stacks into the 32-35 percent brackets. By electing NUA on only 50 percent of the position ($200K FMV, $40K basis), the basis recognition is halved to $40K - which may stay within the 24 percent bracket. The other 50 percent ($200K FMV) is rolled to an IRA.

Drawback of partial NUA: the rolled portion loses Rule of 55 access (if applicable) and becomes locked under IRA rules until 59 1/2 or SEPP. The IRA-rolled basis (the cost portion of the un-selected shares) also disappears - you don't get to recover that basis later. All future withdrawals from the IRA are taxed as ordinary income.

Step-up at death: the partial advantage

NUA stock held until death receives a partial step-up under IRC 1014. The NUA portion (the appreciation that existed at the time of distribution) does NOT step up - heirs receive your original basis on that portion. Post-distribution appreciation DOES step up. This makes NUA stock somewhat less favorable for legacy planning than fully step-up-eligible assets like taxable brokerage stock.

Example: distribute $300K of employer stock with $60K basis and $240K NUA at age 60. Hold until death at 80. Stock is worth $700K at death. Tax pools at death:

• Original basis $60K: heirs receive this as their basis on the basis portion.
• NUA $240K: no step-up. Heirs receive your $60K basis on the original-NUA shares. When they sell, they owe LTCG on $240K (the un-stepped-up NUA).
• Post-distribution appreciation $400K ($700K FMV at death - $300K FMV at distribution): full step-up. Heirs receive $400K basis. Tax-free on this portion.
• If heirs sell at $700K: their gain is $240K (un-stepped-up NUA), at 15-20 percent LTCG plus potential NIIT.

Compare to standard rollover: $300K of IRA balance grown to $700K by death, inherited by non-spouse beneficiaries. Under the SECURE Act 10-year rule, heirs must withdraw the full $700K within 10 years, taxed as ordinary income at their marginal rate (often 22-32 percent for the working-age beneficiaries). Total tax on $700K at 24 percent: $168,000.

NUA path total tax on the same $700K stock position at death: $13,800 (original basis tax paid by parent) + $36-48K (LTCG on NUA at sale) = $50K-$62K. Net legacy savings via NUA: $100K-$118K.

State tax considerations

NUA is a federal Internal Revenue Code election. State tax treatment varies:

• States that conform to federal NUA treatment: Most states (including FL, TX, IL, OH, GA) follow federal NUA rules. The basis is taxed at state ordinary income rates in the year of distribution, and the NUA is taxed at state LTCG rates (which in most states equal ordinary rates - few states preserve federal LTCG preference).
• California (Cal. Rev. & Tax. Code section 17501): Generally conforms to federal NUA treatment for income recognition, but does not preserve LTCG preference. NUA is taxed as ordinary income at up to 13.3 percent state rate. NUA still saves federal tax but provides limited state-level benefit for CA residents.
• No-tax states (TX, FL, NV, WA, TN, SD, WY, AK, NH): NUA timing has no state tax impact. The strategy is purely about federal tax optimization.
• Residency change planning: NUA stock can be distributed while you are a resident of a high-tax state, then sold years later after you have moved to a no-tax state. The basis-recognition tax is paid in the high-tax state, but the LTCG on NUA is taxed in the state of residency at sale. Moving from CA to FL between distribution and sale can save 13.3 percent state tax on the $240K NUA = $31,920.

The mechanics: how to actually execute an NUA distribution

The execution sequence in the 30-60 days after separation:

1. Inventory the 401(k) holdings. Identify the employer-stock position. Confirm with the plan administrator: (a) the cost basis of the shares (typically in plan records), (b) whether the shares can be transferred in-kind to a taxable brokerage, (c) the trade-settlement timeline for in-kind transfers.
2. Open a taxable brokerage account. Schwab, Fidelity, and most major custodians accept in-kind transfers of company stock from 401(k) plans. The receiving account must be a regular taxable brokerage, not an IRA or HSA.
3. Submit distribution paperwork specifying NUA election. The 401(k) administrator must process a "lump-sum distribution with NUA election" - this is a specific paperwork option, NOT the standard rollover form. Many plan administrators are familiar with NUA but require explicit written instructions.
4. Direct rollover of non-stock portion. The remaining 401(k) balance (target-date funds, bonds, other holdings) is rolled directly to your traditional IRA in the same calendar year. This part is a standard rollover and does not affect NUA on the stock portion.
5. Receive Form 1099-R from plan. Box 1: gross distribution (full FMV of all distributed assets). Box 2a: taxable portion (basis of stock plus any cash distributions). Box 6: NUA amount. The plan should also issue separate 1099-R forms for the IRA-rolled portion vs. the stock portion.
6. File Form 8606 if applicable. If you had any after-tax basis in the 401(k) (rare for most employees), Form 8606 tracks the basis recovery.
7. Report on Schedule D when stock is sold. The NUA portion goes on Schedule D as long-term capital gain regardless of post-distribution holding period. Post-distribution appreciation is reported based on actual holding period after distribution.

Key takeaways

• NUA under IRC 402(e)(4) converts the appreciation on employer stock from ordinary income to long-term capital gains. For a $300K position with $60K basis and $240K NUA in the 32 percent bracket, federal tax savings vs. rollover are typically $20K to $30K - and grow further with higher appreciation ratios or larger positions.
• Four strict requirements: lump-sum distribution within one calendar year, qualifying triggering event (separation, death, disability, age 59 1/2), employer securities (not mutual funds holding employer stock), in-kind distribution to a taxable brokerage. Failing any one disqualifies NUA on the entire position.
• The NUA portion is always taxed as long-term capital gain when sold, regardless of post-distribution holding period. Post-distribution appreciation starts a new holding period clock - sell within 12 months and that excess is short-term, hold longer and it qualifies for LTCG.
• NUA stock held until death receives partial step-up under IRC 1014: post-distribution appreciation steps up, but the NUA portion does not. Heirs inherit your original basis on the NUA portion. Despite this, NUA still beats inherited IRA treatment under SECURE Act 10-year rule by $100K-plus on appreciated positions.
• Partial NUA election allows you to take some shares in-kind (with NUA) and roll the rest to an IRA. Useful when basis recognition would push you into a higher bracket. The lump-sum-distribution requirement still applies to the entire 401(k).
• The most common NUA failure: signing the standard rollover form before the plan administrator separates the employer-stock position for in-kind transfer. Once cash is rolled to an IRA, NUA is gone permanently. Verify NUA election language in writing with the plan administrator before processing any distribution.