Which statement BEST describes the tax treatment of a lump sum distribution in the form of employer securities?

The tax treatment of a lump sum distribution in the form of employer securities hinges on how the Internal Revenue Service (IRS) assesses the value of that distribution at different stages. When an employee receives employer securities, the cost basis of those securities—the amount that represents what was originally paid for them—is included as ordinary income at the time of distribution.

However, the appreciation of those securities from the time they were purchased to the time they are received by the employee is treated differently. The unrealized appreciation, which represents the increase in value that has occurred but which has not yet been realized through a sale, is not taxed at the point of distribution. Instead, this amount is subject to capital gains tax once the recipient decides to sell the securities.

This distinction is important because it allows the employee to defer taxation on the appreciation until they realize a gain by selling the securities, potentially leading to favorable long-term capital gains treatment that may apply if the securities are held for more than a year before sale. Thus, this option best captures the nuances of the tax implications involved in the distribution of employer securities.