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Publication: Investor's Notebook
NET UNREALIZED APPRECIATION AND OTHER TAX PITFALLS

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      Investor's Insight - Wednesday, February 1, 2006           
          "A Digest of Investment Opinion From the 
             World's Leading Financial Advisers"


Comment The Post Below...

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NET UNREALIZED APPRECIATION AND OTHER TAX PITFALLS
by Scott Burns

David Foltz was polite about it, but the message remained. 
There was an error in my column on net unrealized appreci-
ation for company stock in 401(k) plans. While I had said 
that such stock received a step-up in cost basis at death, 
escaping taxation of gains altogether, it was more compli-
cated than that. 

Death would not allow us to cheat the taxman.

If anyone knows the nitty-gritty in such matters it is 
David Foltz. He's executive vice president at Texas Capi-
tal Bank in Dallas, in charge of the Wealth Management 
and Trust Group. He's been one of the reigning experts on 
IRAs for more than 20 years.

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So if you're one of the fortunate souls who had a long 
career with ExxonMobil (a group that sometimes seems to 
account for most of the residents of Houston) or someone 
with a low employee number at Dell or XTO Energy, listen 
up. As Foltz explains it, those who exercise the net un-
realized appreciation option with company stock and take 
the stock out of the plan at retirement or separation 
will face two distinct tax events at death.

First, the gain over the cost basis that occurs while the 
stock is in the plan will remain subject to capital gains 
taxes. Then, the gain that occurs from when the stock 
comes out of the plan until death will escape taxation 
through the step-up in cost basis allowed estates.

Suppose, for instance, that you have company stock in your 
401(k) plan with a cost basis of $10 a share that is sell-
ing for $50 a share when you take the stock out of the 
plan. Suppose also that you continue to hold the shares 
and they rise to $250 at your death. What happens?

The gain between $10 and $50 will be liable for capital 
gains taxes when sold. This means an heir could defer taxes 
until they sell the stock. The gain between $50 and $250 
will receive a step-up in cost basis and escape taxation.

I hate to sound like one who prefers blunt instruments, but 
subtleties like this are one of the reasons I believe the 
residents of Congress should experience cruel and unusual 
punishments both before and after death. It's also why I 
advocate the www.fairtax.org proposal for a national sales 
tax.

I asked Foltz if he had a list of the most common errors 
people make.

"The one that comes up routinely is bad information on 
things like required minimum distribution (RMD) factors. 
Last year, for instance, a broker at a major brokerage 
firm and a CPA both cited RMD factors for 2001. In fact, 
the factors had changed and they could have distributed 
less. So they could have paid more taxes than they had to. 

"Had they distributed less than required, there would have 
been a 50 percent penalty from the IRS for underdistribu-
tion.

"Another error is not having a beneficiary designation or 
naming your estate as beneficiary (of a qualified plan). 
People get tired of the paperwork, and the estate has the 
shortest payout."

He pointed out that careful naming of beneficiaries can 
extend the tax-deferral of account assets significantly. 
An IRA that goes into an estate, for instance, would have 
to distribute about 6 percent a year if the decedent was 
72. A group of adult children named as beneficiaries in the 
IRA, on the other hand, could limit distributions to half 
that amount.

"We recommend that the (surviving) spouse declare the IRA 
their own because the Unified Table (for required minimum 
distributions) can still be used. We always have a rollover 
for the surviving spouse.

"What people don't think about is that these accounts are 
going to be around for 70 years or more -- your spouse, your 
children and maybe your grandchildren."

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Another pitfall?

"Not having a power of attorney acceptable to your IRA cust-
odian. That is a common occurrence. The issue is that every-
one thinks in the present tense and forgets about getting 
old."

Those, unfortunately, are just the immediate and common mis-
takes. "IRAs," Foltz concludes, "are becoming increasingly 
important as part of people's estates. It's important that 
your attorney have all the details on these plans, if your 
attorney is to provide good estate planning advice."

ON THE WEB

Journal of Financial Planning, 
"Revisiting Net Unrealized Appreciation":
 
www.fpanet.org/journal/articles/2004_Issues/jfp0204-art7.cfm 

(Investor's Insight reflects the opinions of experts. It does 
not recommend any specific investments, and no endorsement is 
implied or should be inferred. For more information, contact 
the individual firms cited).

COPYRIGHT 2005 UNIVERSAL PRESS SYNDICATE

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