Tax benefits associated with distribution of an employer security

Yes, there is an enormous tax benefit! While most distributions are made in cash, some plans, especially ESOPs, provide for distributions in the form of employer securities - stocks, bonds, or debentures issued by a corporation. If employer securities are distributed as part of a lump sum distribution, the excess of the date-of-distribution fair market value of the employer securities over the plan's cost or basis for the securities, i.e., the unrealized appreciation, is not taxed at the date of the distribution. The trustee's cost basis, however, must be reported by the participant as ordinary income.

When the employer securities are later sold, the unrealized appreciation is taxed at capital gain rates - 20% currently - irrespective of the number of days the employer securities are held. Any gain in excess of the unrealized appreciation is taxed at long or short term capital gain rates depending upon the number of months the employer securities are held. In no other case is "ordinary income" (taxed at more than 40%) converted to "capital gain income" (taxed at 20%).

Of course, if the employer securities are transferred to an individual retirement account, distribution of those same securities from the individual retirement account will not permit the participant to exclude the unrealized appreciation. The distribution of an employer security"> must be from a plan maintained by the employer and not an IRA established by a participant. Otherwise the full value, including the unrealized appreciation, will be taxed as ordinary income.