|
The Employee Stock Ownership Plan or ESOP Legal Tax Angles: How to Save Taxes Without Going to Jail This is a strategy to defer capital gains taxes on selling stock in a closely held corporation when you are ready to retire. The tax benefits of an employee stock ownership plan (ESOP) are absolutely awesome for business owners who want to sell their business without having a big tax bill. Here's a very brief explanation. First, you set up an employee stock ownership plan (ESOP) trust. This is a trust to hold tax qualified retirement assets for employees, but the law permits the ESOP trust to invest any amount of the retirement assets in the stock of the employer corporation. Owners of the corporation who own at least 30% of the corporate stock can then sell their stock to the ESOP Trust for cash. The ESOP Trust gets the cash by taking out a loan with a bank or insurance company. The loan is secured by an obligation of the corporation to make (deductible) employee retirement plan contributions to the ESOP Trust, sufficient to pay off the loan. The trust then uses those retirement plan contributions to pay off the loan from the lender. Meanwhile, if the owner re-invests his sales proceeds in a variety of U.S. corporate stocks or bonds, there is no capital gains tax until those securities are sold. Basically, the ESOP permits you to exchange your corporate stock for a diversified portfolio of income and/or growth investments on a tax deferred basis. This strategy is only useful if your potential capital gain is the result of owning highly appreciated stock in a closely held corporation and if there are employees who would like to have an ownership interest in the business. Income Taxes You can minimize income taxes on the money received from the ESOP trust by investing it in a variety of growth stocks of U.S. corporations rather than in bonds of U.S. corporations. You can also use the other strategies in this report to avoid capital gains taxes when you need to sell some of that stock. The employer corporation will get an income tax deduction for the contributions to the ESOP. The ESOP will most likely borrow from a bank or insurance company to get the cash to buy out the owners when they are ready to retire. Income Shifting As far as I can determine, no gain is triggered if the taxpayer then makes a gift of any other U.S. corporate stocks acquired with funds from an ESOP. It appears that the gain can be transferred to other family members the same as with any other capital gain. Capital Gains Tax Owners of employer stock with an interest of 30% or more of the total voting stock are eligible to sell their corporate stock to the ESOP for cash and to then re-invest that cash in listed securities of U.S. corporations on a tax deferred basis. The cost of the stock sold to the ESOP is substituted as the cost of the new securities acquired. Estate and Gift Taxes The deferred tax does not appear to be triggered at death, as is the case with a pension plan. Thus, replacement securities purchased with funds from an ESOP are treated the same as other appreciated securities at death. The securities acquired with funds from an ESOP would be valued at their market value at the date of death or the alternate valuation date. Although the securities in the estate would be subject to estate taxes, they would not also be subject to income taxes or capital gains taxes. Suitability The Employee Stock Ownership Plan is only suitable for the owner(s) of a business that has enough employees to be able to use deductible pension plan contributions to buy out the owner(s) of the company. As a practical matter, the company needs to be well enough established in the marketplace so that the customers will continue with the business even after the owner(s) sell the company to their employees. An ESOP requires that the employer corporation must be a taxable C corporation. It would not be suitable for an S corporation. Implementation The establishment of an ESOP can be a costly process. The business must be appraised every year by a qualified appraiser. The ESOP is a qualified employee retirement savings plan that must satisfy the various requirements of ERISA and the applicable tax code sections. Tax Risk This is a complex area of tax law that is in a frequent state of change. Highly qualified specialists with extensive experience in this area of the law should be utilized. Citations Internal Revenue Code Section 409 and 1042 Vern Jacobs Copyright, 2003 |
Books and Services by Vern Jacobs
|
.jpg)
