Company Stock in a 401(k): NUA Rules, Penalties, and 1099-R

The NUA tax treatment for company stock in a 401(k) lets you pull employer shares out of the plan, pay ordinary income tax only on what the plan originally paid for them, and defer tax on the appreciation until you sell, when that growth is taxed at the long-term capital gains rate instead of your full income tax rate. Net Unrealized Appreciation is the name for that spread between cost basis and market value, and the savings can be significant if your shares are deeply appreciated. Miss one of the rules, though, and the entire value is taxed as ordinary income.

What Net Unrealized Appreciation Actually Is

NUA is the difference between the cost basis of your employer shares (what the plan paid for them) and their market value on the day they leave the plan. Federal tax law lets you exclude that appreciation from gross income at distribution and defer the tax until you sell the shares in a taxable brokerage account.¹ When you sell, the NUA portion gets the long-term capital gains rate regardless of how long you actually held the stock after it came out of the plan.

Long-term capital gains rates for 2026 are 0%, 15%, or 20% depending on taxable income.² The top ordinary income rate is 37%.³ The gap between those two numbers is the entire reason the strategy exists. NUA treatment only applies to employer securities. Mutual funds, bonds, and other investments inside the same plan don’t qualify.

Once you make a qualifying NUA distribution, the value of the stock splits into three pieces for tax purposes:

The cost basis is taxed as ordinary income in the year of distribution.
The NUA itself (growth from basis to market value on the distribution date) is taxed as a long-term capital gain whenever you sell, no holding period required.
Any additional gain after the distribution date follows normal capital gains rules: long-term if you hold more than a year after distribution, short-term if you sell sooner. The NUA portion keeps its long-term treatment either way.

A quick example. The plan bought your stock for $20,000. On distribution day it’s worth $120,000. Six months later you sell for $130,000. The $20,000 cost basis is ordinary income in the distribution year. The $100,000 NUA is a long-term capital gain when you sell. The $10,000 of post-distribution appreciation is a short-term capital gain, because you held it less than a year.

What You Have to Do to Qualify

NUA is not automatic. Three requirements all have to be satisfied, and missing any one of them wipes out the benefit for the entire distribution.

A Triggering Event

The distribution has to follow one of these events:⁴

Separation from service. This is available only to common-law employees, not to self-employed participants.¹
Reaching age 59½, whether or not you’ve left the company.
Disability, which under the statute applies only to self-employed participants.
Death. Beneficiaries can elect NUA on inherited employer stock.

A Lump-Sum Distribution

Your entire account balance has to leave the plan within a single tax year, and “entire balance” means every account in every qualified plan of the same type with that employer.⁴ A 401(k) and a profit-sharing plan with the same company both need to be emptied in the same calendar year. If you took a partial distribution before a triggering event, you may already have disqualified yourself from lump-sum treatment. Timing is where people trip.

An In-Kind Transfer of the Shares

The employer stock has to move directly to a taxable brokerage account as actual shares. If the plan sells the stock and sends cash, NUA treatment is lost. The non-stock assets don’t have to come with it: you can roll the cash, mutual funds, and other holdings into an IRA while taking only the employer shares in kind.¹ That split lets you preserve NUA on the stock and keep the rest tax-deferred.

If a distribution doesn’t meet all three tests, the entire market value of the stock is taxed as ordinary income in that year. There is no partial NUA.

The 10% Penalty and the 3.8% Surtax

If you take the distribution before age 59½, the 10% early withdrawal penalty applies to the cost basis portion, since that’s what’s included in gross income. The NUA and any post-distribution appreciation are not subject to the 10% penalty regardless of age. There’s an exception that often matters: if you separate from service during or after the calendar year you turn 55, the cost basis portion can also escape the 10% penalty under the age-55 rule for employer plan distributions.

The 3.8% Medicare surtax works in your favor on the NUA itself, which is not treated as net investment income. Post-distribution appreciation does count, and can trigger the surtax if your modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married filing jointly.

When NUA Pays Off, and When It Doesn’t

The strategy works best when cost basis is small compared to current value. Shares the plan bought at $5 that are now worth $80 produce a large spread between the ordinary income you pay on $5 and the capital gains rate on $75. The math gets worse fast as basis climbs.

Consider stock the plan bought for $400,000 that’s now worth $500,000. Electing NUA means paying ordinary income tax immediately on $400,000 to get capital gains treatment on $100,000 of appreciation. In most cases that’s a poor trade, and rolling everything into an IRA to defer all the tax is the better move.

Diversification is the other factor people underweight. Once the shares sit in a taxable brokerage account, selling to diversify triggers the capital gains tax, and that tax bill makes people reluctant to sell. The result can be a dangerously concentrated position in a single company’s stock. No tax savings justifies that risk.

A few rough guides:

Low cost basis and high NUA: the strategy tends to pay off.
High cost basis and low NUA: the immediate tax on the basis usually swallows the capital gains savings.
Young participant still working: giving up decades of tax-deferred compounding inside an IRA may not be worth the benefit, particularly if your retirement bracket will be lower.
Company stock as a large share of your net worth: concentration risk alone can argue against NUA.

The Alternative: Roll Everything to an IRA

If the lump-sum rules don’t fit or the NUA math doesn’t work, the standard move is rolling the entire 401(k) balance, employer stock included, into a traditional IRA. The full value stays tax-deferred, and nothing is taxed until you take withdrawals, which are then ordinary income at your rate that year.⁴

Rolling the stock into an IRA permanently kills the NUA election for those shares. You cannot roll employer stock into an IRA and later claim NUA when you sell. The choice is made at distribution, and it’s irreversible.

What to Check on Form 1099-R

Your plan administrator reports the distribution on Form 1099-R.⁵ Three boxes carry the NUA information:

Box 1 (Gross Distribution): total value of the distribution, including the NUA.
Box 2a (Taxable Amount): gross distribution minus the NUA. For a clean NUA election, this is effectively the cost basis taxable as ordinary income that year.
Box 6 (Net Unrealized Appreciation in Employer’s Securities): the NUA amount, which is what will be taxed as long-term capital gain when you sell.⁶

If Box 6 is blank, the administrator either didn’t calculate the NUA or treated the distribution as ineligible. If you believe you qualify, call the administrator before you file.

1
Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
2
Internal Revenue Service. Topic No. 409 Capital Gains and Losses
3
Internal Revenue Service. Federal Income Tax Rates and Brackets
4
Internal Revenue Service. Topic No. 412, Lump-Sum Distributions
5
Internal Revenue Service. Instructions for Forms 1099-R and 5498
6
Internal Revenue Service. Form 1099-R – Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.