ESOP Rollover

ESOP Tax Advantages


ESOP Rollover

An additional ESOP incentive allows a shareholder, or shareholders, of a closely held C corporation to sell stock in the company to the firm’s ESOP and defer federal income taxes on the gain from the sale. In order to qualify for this “rollover,” the ESOP must own at least 30% of the company’s stock immediately after the sale, and the seller(s) must reinvest the proceeds from the sale in the securities of domestic operating corporations within fifteen months, either three months before, or twelve months after the sale. The seller, certain relatives of the seller, and 25% shareholders in the company are prohibited from receiving allocations of stock acquired by the ESOP trough a rollover. Generally, the ESOP may not sell the stock acquired through a rollover transaction for three years.

The ESOP rollover provides a substantial tax advantage that might otherwise be unavailable to current or retiring owners. Normally, a direct shareholder’s options would be to sell shares back to the company, if such a transaction is feasible, or to sell out to another company, either for cash or for a block of shares in the other company. Selling to an ESOP, on the other hand, allows the seller to exchange interest in the company for a safely diversified portfolio of securities or the stock of a single new company without paying any taxes on the transaction. The seller’s tax basis in the employer stock which were sold will be carried over to the replacement property. If the replacement property is held until death, however, a stepped-up basis for those securities is provided under current established tax laws.

In addition to the substantial tax advantages, selling to the ESOP preserves the company’s independent identity. A sale to an ESOP also provides a significant financial benefit to valued employees and can assure the continuation of jobs. Moreover, selling to an ESOP allows the seller to sell all or just a part interest in the company, and to do this gradually or all at once.

To qualify for rollover treatment, the stock sold to the ESOP must be common or convertible preferred stock of a closely held domestic corporation and must have been owned by the seller for at least three years.

Note, the owner of S corporation stock that she/he sells to an ESOP is not eligible for the ESOP rollover tax benefit. Finally, if a C corporation pays dividends in cash to ESOP participants, and the participant decides the dividends he reinvented to acquire more employer securities for his or her account, the C corporation may take a tax deduction for the value of the dividends.

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