Munn & Morris Financial Advisors, Inc.Phil Orwig, CFPFinancial Planner14180 Dallas ParkwaySuite 530Dallas, TX 75254972-692-0909porwig@munnmorris.comwww.munnmorris.comNet Unrealized Appreciation:The Untold StoryAugust 11, 2015If you participate in a 401(k), ESOP, or other qualifiedretirement plan that lets you invest in your employer'sstock, you need to know about net unrealizedappreciation--a simple tax deferral opportunity with anunfortunately complicated name.When you receive a distribution from your employer'sretirement plan, the distribution is generally taxable toyou at ordinary income tax rates. A common way ofavoiding immediate taxation is to make a tax-freerollover to a traditional IRA. However, when youultimately receive distributions from the IRA, they'llalso be taxed at ordinary income tax rates. (Specialrules apply to Roth and other after-tax contributionsthat are generally tax free when distributed.)But if your distribution includes employer stock (orother employer securities), you may have anotheroption--you may be able to defer paying tax on theportion of your distribution that represents netunrealized appreciation (NUA). You won't be taxed onthe NUA until you sell the stock. What's more, theNUA will be taxed at long-term capital gainsrates--typically much lower than ordinary income taxrates. This strategy can often result in significant taxsavings.What is net unrealized appreciation?A distribution of employer stock consists of two parts:(1) the cost basis (that is, the value of the stock whenit was contributed to, or purchased by, your plan), and(2) any increase in value over the cost basis until thedate the stock is distributed to you. This increase invalue over basis, fixed at the time the stock isdistributed in-kind to you, is the NUA.For example, assume you retire and receive adistribution of employer stock worth $500,000 fromyour 401(k) plan, and that the cost basis in the stockis $50,000. The $450,000 gain is NUA.How does it work?At the time you receive a lump-sum distribution thatincludes employer stock, you'll pay ordinary incometax only on the cost basis in the employer securities.You won't pay any tax on the NUA until you sell thesecurities. At that time the NUA is taxed at long-termcapital gain rates, no matter how long you've held thesecurities outside of the plan (even if only for a singleday). Any appreciation at the time of sale in excess ofyour NUA is taxed as either short-term or long-termcapital gain, depending on how long you've held thestock outside the plan.Using the example above, you would pay ordinaryincome tax on $50,000, the cost basis, when youreceive your distribution. (You may also be subject toa 10% early distribution penalty if you're not age 55 ortotally disabled.) Let's say you sell the stock after tenyears, when it's worth $750,000. At that time, you'llpay long-term capital gains tax on your NUA($450,000). You'll also pay long-term capital gains taxon the additional appreciation ($250,000), since youheld the stock for more than one year. Note that sinceyou've already paid tax on the $50,000 cost basis,you won't pay tax on that amount again when you sellthe stock.If your distribution includes cash in addition to thestock, you can either roll the cash over to an IRA ortake it as a taxable distribution. And you don't have touse the NUA strategy for all of your employerstock--you can roll a portion over to an IRA and applyNUA tax treatment to the rest.What is a lump-sum distribution?In general, you're allowed to use these favorable NUAtax rules only if you receive the employer securitiesas part of a lump-sum distribution. To qualify as alump-sum distribution, both of the following conditionsmust be satisfied: It must be a distribution of your entire balance,within a single tax year, from all of your employer'squalified plans of the same type (that is, allpension plans, all profit-sharing plans, or all stockbonus plans) The distribution must be paid after you reach age59, or as a result of your separation from service,All investing involvesrisk, including the loss ofprincipal. This discussionexplains the taxtreatment that may beavailable when employerstock is held in aqualified retirement plan.While the examples usedin the discussion showsuch stock increasing invalue over time, it isimportant to understandthat any shares of stockheld in a retirement plan,including shares ofemployer stock, can losesome or all of their valueover time.Page 1 of 2, see disclaimer on final pagePrepared by Broadridge Investor Communication Solutions, Inc. Copyright 2015This information, developed by an independent third party, has been obtained from sources considered to be reliable, but Raymond JamesFinancial Services, Inc. does not guarantee that the foregoing material is accurate or complete. This information is not a complete summary orstatement of all available data necessary for making an investment decision and does not constitute a recommendation. The informationcontained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Thisinformation is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitablefor all investors. The material is general in nature. Past performance may not be indicative of future results. Raymond James Financial Services,Inc. does not provide advice on tax, legal or mortgage issues. These matters should be discussed with the appropriate professional.Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC, an independent broker/dealer, and are not insuredby FDIC, NCUA or any other government agency, are not deposits or obligations of the financial institution, are not guaranteed by the financialinstitution, and are subject to risks, including the possible loss of principal.or after your deathThere is one exception: even if your distributiondoesn't qualify as a lump-sum distribution, anysecurities distributed from the plan that werepurchased with your after-tax (non-Roth)contributions will be eligible for NUA tax treatment.NUA at a glanceYou receive a lump-sum distribution from your401(k) plan consisting of $500,000 of employerstock. The cost basis is $50,000. You sell thestock 10 years later for $750,000.*Tax payable at distribution--stock valued at$500,000Cost basis--$50,000 Taxed at ordinary incomerates; 10% early paymentpenalty tax if you're not 55or disabledNUA--$450,000 Tax deferred until sale ofstockTax payable at sale--stock valued at $750,000Cost basis-- $50,000 Already taxed atdistribution; not taxedagain at saleNUA-- $450,000 Taxed at long-term capitalgains rates regardless ofholding periodAdditionalappreciation--$250,000Taxed as long- orshort-term capital gain,depending on holdingperiod outside plan(long-term in this example)*Assumes stock is attributable to your pretaxand employer contributions and not after-taxcontributionsNUA is for beneficiaries, tooIf you die while you still hold employer securities inyour retirement plan, your plan beneficiary canalso use the NUA tax strategy if he or she receivesa lump-sum distribution from the plan. The taxationis generally the same as if you had received thedistribution. (The stock doesn't receive a step-up inbasis, even though your beneficiary receives it asa result of your death.)If you've already received a distribution of employerstock, elected NUA tax treatment, and die before yousell the stock, your heir will have to pay long-termcapital gains tax on the NUA when he or she sells thestock. However, any appreciation as of the date ofyour death in excess of NUA will forever escapetaxation because, in this case, the stock will receive astep-up in basis. Using our example, if you die whenyour employer stock is worth $750,000, your heir willreceive a step-up in basis for the $250,000appreciation in excess of NUA at the time of yourdeath. If your heir later sells the stock for $900,000,he or she will pay long-term capital gains tax on the$450,000 of NUA, as well as capital gains tax on anyappreciation since your death ($150,000). The$250,000 of appreciation in excess of NUA as of yourdate of death will be tax free.Some additional considerations If you want to take advantage of NUA treatment,make sure you don't roll the stock over to an IRA.That will be irrevocable, and you'll forever lose theNUA tax opportunity. You can elect not to use the NUA option. In thiscase, the NUA will be subject to ordinary incometax (and a potential 10% early distribution penalty)at the time you receive the distribution. Stock held in an IRA or employer plan is entitled tosignificant protection from your creditors. You'lllose that protection if you hold the stock in ataxable brokerage account. Holding a significant amount of employer stockmay not be appropriate for everyone. In somecases, it may make sense to diversify yourinvestments.* Be sure to consider the impact of any applicablestate tax laws.When is it the best choice?In general, the NUA strategy makes the most sensefor individuals who have a large amount of NUA and arelatively small cost basis. However, whether it's rightfor you depends on many variables, including yourage, your estate planning goals, and anticipated taxrates. In some cases, rolling your distribution over toan IRA may be the better choice. And if you wereborn before 1936, other special tax rules might apply,making a taxable distribution your best option.If you're expecting adistribution of employersecurities from aqualified retirement plan,make sure you speakwith your financial or taxprofessional before youtake any action so thatyou can fully explore andunderstand all theoptions available to you.Only then can you beassured of making thedecision that best meetsyour individual tax andnontax goals.*Diversification is amethod used to helpmanage investment risk;it does not guarantee aprofit or protect againstinvestment loss.Page 2 of 2