Tax treatment of ESOPs ( Employee Stock Ownership Plan)

Karin Price Mueller/The Star-Ledger   writes: Question. I have just made a direct rollover from an Employee Stock Ownership plan, or ESOP, to an IRA. Do I pay the New Jersey income tax on the rollover amount this tax year, or in the year it is withdrawn? Can I take a deduction?

— Jim in Montville

Answer. Ah, that’s a question you should have asked before you made the move — just so you’d know what you were getting into.

"The New Jersey Gross Income Tax Act does not contain provisions similar to the Internal Revenue Code which permit deductions for contributions to IRA accounts," said Jeffrey Boyer, a certified financial planner with RegentAtlantic Capital in Morristown. "If one makes a federally deductible IRA contribution of $5,500 in 2013, the state of New Jersey does not provide a deduction on the state return."

Then, when the funds are distributed from an IRA, the amount you contributed is not taxable for New Jersey income tax purposes.

Boyer said that’s an important thing for retirees to remember because sometimes IRA withdrawals are overlooked when filing the state income tax return. You can learn more from the Division of Taxation.

On your specific question, direct rollovers from qualified plans to an IRA account do not trigger tax at the federal or state level. This includes rollovers 401(k) plans, ESOPs or other qualified retirement plans.

"For a New Jersey resident, the rollover of an eligible plan is excludable from New Jersey income if the rollover qualifies for deferral for federal tax purposes," said Cynthia Fusillo, a certified public accountant with Lassus Wherley in New Providence. "The rollover must be made within a 60 day period following the distribution, or be a direct trustee-to-trustee transfer of assets to qualify."

On the topic of ESOPs, specifically, it’s important that investors fully consider their options when making rollovers or distributions of company stock.

Boyer says there’s a strategy to consider.

"A special taxation method called net unrealized appreciated, or NUA, is preserved for employees which allows for appreciation to be treated as a capital gain, rather than ordinary income," Boyer said. "If you do have appreciated company stock in a qualified plan, be certain to check with your tax professional before rolling it over to an IRA to take advantage of the NUA treatment."

Once you make the rollover to an IRA, the decision is irrevocable, and the NUA tax opportunity will be lost, he said.