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Selling Your Business To An ESOP

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Selling Your Business To An ESOP

 

Employee stock ownership plans (“ESOPs”) are defined contribution retirement plans designed primarily to invest in employer stock. ESOPs qualify for special breaks to encourage employee ownership. They can borrow to buy employer stock; employers can deduct plan contributions above and beyond regular limits to repay plan loans; and employers can generally deduct dividends paid on ESOP stock. But most employers who adopt ESOPs do so to let owners sell stock and postpone tax on the gain. This is a powerful tool for owners who qualify:

  • You have to own your stock for at least three years. You can’t acquire your stock from a qualified plan, exercising stock options, or an employee stock purchase plan.
  • The ESOP has to own at least 30% of the corporation after the sale. You can sell up to 50% of the stock and keep control of the business, or sell up to 100% to exit completely.
  • You have 15 months (beginning three months before the sale and ending 12 months after) to reinvest your proceeds in “qualified domestic securities.” These are stocks or bonds issued by domestic corporations using at least 50% of their assets in active trade or business and whose passive income for the preceding year does not exceed 25% of gross receipts.
  • If you sell those securities during your lifetime you’ll owe tax on your original gains and any gains on your replacement securities. Consider reinvesting your proceeds in special “ESOP notes” which let you borrow up to 90% of their value to draw equity or diversify without selling. These are adjustable-rate notes issued by top-rated borrowers, with terms up to 60 years, and rates pegged to short-term commercial paper.
  • Replacement securities enjoy stepped-up basis at your death. This lets you avoid tax on your gains entirely.

ESOPs aren’t cheap to establish or operate. Legal fees and initial valuations generally range from $5,000 up. Annual administration and valuations add more. This makes ESOPs most appropriate for businesses valued at $1 million or more, with long-term employees you’d like to reward.

 

 

 

 

 

 

 

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