My question involves the completion of IRS Forms 1099-R in connection with the following Slott Report, which outlines a 3-step approach for taking both a Required Minimum Distribution (RMD) and Net Unrealized Appreciation (NUA) during the first RMD year. The Slott Report reads as follows:
“USING NUA FOR AN RMD – 3 STEPS
Monday, August 05, 2019
By Andy Ives, CFP®, AIF®
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"Many company retirement plans – like a 401(k) – offer company stock as an investment option. Under special tax rules, a plan participant can withdraw the stock and pay regular (ordinary) income tax on it, but only on the original cost and not on the market value, i.e., what the shares are worth on the date of the distribution. The difference (the appreciation) is called the net unrealized appreciation (NUA). NUA is the increase in the value of the employer stock from the time it was acquired to the date of the distribution to the plan participant.
"The plan participant can elect to defer the tax on the NUA until he sells the stock. When he does sell, he will only pay tax at his current long-term capital gains rate – even if the stock is held for less than one year. To qualify for the tax deferral on NUA, the distribution must be a lump-sum distribution. This means the entire plan must be emptied in one calendar year, including all non-company stock within the plan. The distribution must also occur after any one of four triggering events: reaching age 59½; separation from service (not for self-employed); disability (only for the self-employed); or death.
"At age 70 ½, a plan participant has hit the 59 ½ trigger event and may have also hit the separation from service event. Assuming one of these is still available and was not lost due to poor planning, NUA for the RMD is still alive. NUA stock can be used to satisfy a required minimum distribution (RMD), but the ordering and timing of the transactions are critical to success.
"Typically, when an NUA transaction is done, all non-NUA stock and other assets are first rolled over to an IRA. Then the NUA shares are journaled to a “regular” (non-qualified) brokerage account. However, if an RMD is involved, this will create a problem. Why? RMDs can’t be rolled over. Here’s a workaround:
"Step 1 - If a client needs to take an RMD, the first-dollars-out rule dictates that the first withdrawal counts toward the RMD. The first step would be to journal/transfer the appropriate amount of NUA shares out to a non-qualified brokerage account to cover the RMD. (RMDs are not subject to the 20% withholding rule because they cannot be rolled over, so this is of no concern.)
"Step 2 – Next is a direct rollover/transfer of all non-NUA stock investments to an IRA. Any cash, mutual funds or other investments in the plan must be removed. As long as they are properly relocated to an IRA, the movement of non-NUA cash and investments will not be a taxable event.
"Step 3 - With nothing left in the account except the NUA stock, and with no cash or other assets remaining to force a 20% withholding, the last of the NUA stock would be journaled to the regular non-qualified brokerage account. Be careful! Any NUA stock moved into an IRA will NOT qualify for the special tax break.
"By following these steps, the RMD can be fully satisfied with NUA stock first, and the NUA lump sum distribution process can follow. Another benefit is that the full value of the NUA stock will count toward the RMD, not just the basis. (Just be sure these transactions are all done in one calendar year!)”
To illustrate that understanding let’s use an example based on the following assumptions:
(a) Individual is married to a spouse that is less than 10 years younger
(b) Year and month in which individual turns 70 ½ years old: April 2019
(c) Calendar year for taking both the 2019 and 2020 RMD: 2020
(d) Fair market value of all assets in the 401(k) at time of initial distribution: $2,900,000
(e) There have been no distributions of any assets in 401(k) since separation of individual from employment with employer, except for distributions of dividends issued on the employer stock
(f) The only stock in the 401(k) is the employer stock, and the fair market value of employer stock eligible for NUA at end of both 2018 and 2019 is $900,000, consisting of 18,000 shares valued at $50 per share
(g) Cost basis of employer stock eligible for NUA at time of initial distribution: $160,000
(h) Employer maintains no record of cost associated with individual shares of stock, so the cost basis for each share is the same.
Since the only distributions from the 401(k) following the individual’s separation from employment with the employer consisted solely of dividends issued on the employer stock (i.e. the dividend distributions are reported in Box 7 as “U” on IRS Form 1099-R, with no marking in the IRA/SEP/SIMPLE box), the individual qualifies for NUA tax treatment.
(1) Step 1 requires the distribution of the employer stock in an amount equal to total RMD for both 2019 and 2020. Since the 2019 RMD must be taken prior to April 1, 2020, this distribution must occur before that date. Based on applicable IRS table, the RMD required for 2019 is $109,434 and the RMD required for 2020 is $113,281, for a total of $222,715. For simplicity the individual will have 4,460 shares of the employer stock valued at $223,000 distributed as the total RMD and have the shares transferred to a non-qualified brokerage account.
(2) Step 2 requires that all cash and non-employer stock be distributed in a qualified rollover to a qualifying individual retirement account (IRA). Based on this example, $2,900,000 - $900,000 = $2,000,000 will be distributed in a direct rollover to an IRA.
(3) Step 3 requires the remaining employer stock to be distributed to a non-qualified brokerage account. Based on this example, $900,000 - $223,000 = $677,000 worth of employer stock will be deposited into that account.
Based on the above scenario, I believe that there should be three IRS Forms 1099-R issued by the 401(k) custodian, with each reflecting the following information:
Form 1099-R for IRA rollover:
Box 1 - $2,000,000
Box 2a - $0
Box 7 - G with no marking in IRA/SEP/SIMPLE box
Form 1099-R for NUA:
Box 1 - $900,000
Box 2a - $160,000
Box 6 - $740,000
*Box 7 - 7 with no marking in IRA/SEP/SIMPLE box
Form 1099-R for RMD:
Box 1 - $223,000
*Box 2a - $0
Box 7 - 7 with no marking in IRA/SEP/SIMPLE box
Is the above correct? I am somewhat uncertain on the two boxes marked with an asterisk, as I was unable to find any explicit IRS or other pronouncements on what information to insert here.