Sell Closely Held Stock to an Employee Stock Ownership Plan

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 help corporation and if there are employees who would like to have an ownership interest in the business.

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.

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