Normally, when you take funds out of a workplace 401k plan, you pay income tax on the full amount of the withdrawal, unless you roll it over into an IRA or other qualified plan. However, there is an exception if you take the distribution in the form of stock. In that case, you don't pay income taxes, but the lower long-term capital gains rate on any appreciation. However, if the stock in your plan fell since it was acquired, you won't have any net unrealized appreciation. Instead, you generally report negative NUA as zero on your individual income tax return.
1. Obtain a Form 1099-R from your employer. This form will list the details of your qualified plan distribution. Your employer or the plan administrator will forward a copy to the Internal Revenue Service.
2. Fill out an IRS Form 1040, Individual Income Tax Return.
3. Download the appropriate form for reporting lump-sum distributions for qualified accounts. If you were born prior to January 2, 1936, fill out IRS Form 4972, and enter the capital gain amount listed in Box 3 of your Form 1099-R in Part II, Line 6 of form 4972. IRS instructions, however, advise employers or plan sponsors not to enter a negative number onto the form. In other circumstances, you would be able to use the capital losses to offset capital gains. However, the IRS advises plan administrators not to enter a negative number on a form 1099-R. If they don't enter a negative number, you won't get credit for negative net unrealized appreciation. The number in the block will be zero.
4. Fill out Schedule D, Capital Gains and Losses. This is the form to use if you were born on January 2, 1936 or later. If your employer or your employer's representative filled out the 1099-R correctly, it would not show a negative number anywhere in the form. If your NUA was negative, your capital gains and capital losses, for the sake of determining your tax liability on NUA, is zero.
- Taxation on lump sum distributions from retirement plans can be very technical and complex -- with major tax consequences if you make a mistake. It's important to make these decisions after consulting with a qualified and experienced tax advisor or retirement planning specialist.