Lump Sum distribution - NUA tax treatment

Client has two retirement accounts that hold NUA shares.

One account is an employee stock option plan with a basis of 33k and a market value of $338k
The second account is his 401(k) and it holds only common shares of his companies stock, with a basis of $543k and a market value of $3.6M

Client will turn 72. He wants to transfer all of his NUA shares from his retirement account into an ordinary brokerage account, and transfer the NUA status. He is doing this to avoid large RMDs.

Client has previously received distributions from his ESOP in the form of annual dividends. The clients broker has notified us that they are unsure if my client is eligible for NUA status on this rollover. Their concern is he will not have a “triggering” event because he has previously taken the ESOP dividends after turning age 59.5. I do not know the answer.

Is he still working? Assuming no, then I have same issue as broker. The first distribution after a triggering event(2 a or c below) was a dividend and not a total Lump Sum. Therefore only NUA option is beneficiaries get NUA after cleints death( trigger event 2 b).

1. If an ESOP pays dividends directly to participants, those dividends are not subject to the excise tax of early distributions. They are also exempt from income tax withholding — but dividend payments are fully taxable. Whenever participants receive ESOP distributions of $10 or more, the ESOP trustee or third-party administrator (TPA) is required to prepare and submit Forms 1099-R and 945 for ESOP taxation reporting.

2. There are three such Triggering Events outlined by the Internal Revenue Code that apply for employees who may be eligible for NUA. They are:
a.Attainment of age 59 ½. To use this Triggering Event, a plan participant must actually be 59 ½ or older (not ‘just’ in the year in which they turn 59 ½)
b.Death. Once a plan participant dies, the balance of the funds in their account belongs to their beneficiary. Accordingly, “death” (of an account owner) should be viewed as more of a Triggering Event for a beneficiary.
c. Separation From Service. This Triggering Event applies regardless of whether the plan participant’s separation was voluntary or not.

Client is still working. I am not sure if his intention is to retire at this time, I am trying to clarify.

Assuming he is not, can he still transfer NUA status on the 401(k) account, since the dividends came from his ESOP shares only?

Client is still working. I am not sure if his intention is to retire at this time, I am trying to clarify.

Then no problem, he just waits to do the NUA until he separates from service a trigger event. In the meantime he could roll over just the Non NUA funds to IRA if he wanted or wait and do at time he does the NUA total distribuion.

I was incorrect, he has long ago retired.

He has two plans. One is his ESOP plan which has taken dividend distributions. The second is his 401(k) which has not taken distributions, and holds 90% of the balance of his retirement plans. Both hold ESOP shares, and he wants to transfer both.

He retired in 2005 at age 55. He began to take ESOP dividend distributions in 2007 when he would have been age 57. Those have continued every year.

He should become re-eligible for NUA with a new triggering event when he turned 59.5. But he continued to take the dividend distributions from the ESOP plan. In my mind he should still be eligible for NUA on his 401(k) and his ESOP should be kept intact or rolled in to an IRA. But I really don't want to cause the taxation of $3.1 million.

This short article references two PLRs that indicate the receipt of dividends from employer stock in an ESOP does not negate NUA treatment.

https://retirementlc.com/does-the-receipt-of-dividends-on-employer-stock-held-in-a-401k-plan-negate-a-lump-sum-distribution/#_ftn1

Thank you so much.

This short article references two PLRs that indicate the receipt of dividends from employer stock in an ESOP does not negate NUA treatment.

Nice cite. Apparently dividends are paid under separate contract from the employees account balance.