Introduction
In the globalised corporate environment, if you are an Indian professional working for multinational corporations based in the U.S. you receive company stock as compensation. Often, this stock is held in retirement accounts such as a 401(k). Understanding Net Unrealised Appreciation (NUA) can help you achieve significant tax savings when disposing of these assets. NUA is a tax strategy unique to the U.S. Still, it can be essential for you as an expatriate, or if you work for companies such as Amazon or Microsoft that offer stock plans in the U.S. This article defines NUA, goes over the net unrealised appreciation tax treatment, and provides information on how you can adequately use the NUA tax strategy to your benefit.
What is Net Unrealised Appreciation?
Net Unrealised Appreciation is the ability to realise the gain on the value of your stock held in a 401(k) U.S. qualified retirement plan; from the date the token is acquired to its market value on distribution. NUA is the difference between the original cost basis of the stock (what the employee paid for it via contributions) and its market value when you withdraw it from the plan. This generally applies to company stock acquired through Employee Stock Ownership Plans (ESOPs) or other similar incentives given in a U.S. retirement account.
For instance, imagine you are an engineer at a U.S. tech firm with 401(k) stock in her company. If the stock's cost basis is ₹8 lakh (approximately $10,000) and its market value at distribution is ₹40 lakh ($50,000), the NUA is ₹32 lakh ($40,000). This unrealised gain is the crux of the NUA strategy since it is taxed more favourably under U.S. tax law.
How Does the NUA Strategy Work?
The NUA strategy aims to help you pay less tax on employer stock from a retirement plan. Rather than rolling the stock into an individual retirement account (IRA), where withdrawals are taxed as ordinary income, you can transfer employer stock to a taxable brokerage account.
Here is how the strategy works:
Lump-sum distribution: The NUA strategy requires you to take a lump-sum distribution of the entire balance of your retirement plan in a single tax year following a qualifying event, such as leaving the company, retiring as an employee, or reaching age 59½.
Tax treatment: The cost basis of the stock distribution is taxed as ordinary income in the year of distribution. The NUA is taxed at the lower long-term capital gains rate (typically 15-20% in the U.S.), but the NUA is only taxed when the stock is sold, regardless of how long you hold the stock after the distribution.
Example: In the previous example, the ₹8 lakh cost basis will be taxed as ordinary income when withdrawn. The ₹32 lakh NUA will be deferred and taxed at U.S. capital gains rates once it's sold, which could save you thousands of dollars lower than ordinary income tax rates (potentially as high as 37%).
Relevance for Indian Professionals
While NUA is a strategy primarily framed for the U.S. markets, it applies to you as a professional working for U.S.-based employers with retirement plans in which it may be eligible to distribute your employer stock. This NUA strategy is not possible in India’s ‘Employees' Provident Fund (EPF), or National Pension Scheme (NPS), which provide fixed tax treatments; therefore, NUA is another way to optimise taxes on stock gains.
However, it's not for everyone. The strategy works best when:
For most Indian employees, ESOPs are taxed as perquisites at exercise or capital gains upon sale, with no NUA equivalent. Therefore, NUA will apply only to those with U.S. 401(k) assets.
How to Use NUA
To take advantage of the NUA strategy, you can:
Determine Eligibility: Confirm that you qualify for a lump-sum distribution (e.g., job change position or retirement).
Estimate Potential NUA: Calculate the NUA by comparing the stock's cost basis to its value. A higher NUA indicates a greater tax benefit.
Communicate with Plan Administrator: Liaise with your employer's 401(k) administrator to transfer the stock into a brokerage account, not an IRA.
Estimate tax payments: Set aside the money to pay the immediate tax on your cost basis and seek consultation from a tax professional to comply with U.S.-India tax obligations.
Timing the sale: Consider holding on to the stock if you anticipate it will continue to appreciate, as NUA only triggers capital gains tax upon selling the described investment.
Challenges and Risks
The NUA strategy is not without its risks, such as rolling over to an IRA without completing the lump-sum distribution or rolling over stock into an IRA that would otherwise not qualify for NUA and therefore not qualify for tax. You may face currency fluctuation risk (INR vs. USD), and the tax reporting process can be complex. In addition, if the stock value goes down after distribution, the tax benefit from deferral may decrease.
Conclusion
Net unrealised appreciation presents U.S. retirement plan participants and Indian professionals with a significant opportunity to mitigate taxes on employer stock. If you can sufficiently and accurately understand the net unrealised appreciation tax treatment, thereby employing the NUA strategy, there is an opportunity to yield superior returns from employer stock as you navigate the U.S. and Indian tax systems. However, careful planning and professional expertise are needed to avoid pitfalls and ensure compliance with cross-border regulations. If you are an Indian employee looking for global employment opportunities, learning and utilising NUA can be a significant opportunity to accumulate wealth strategically.