On January 2, 2013, President Obama signed the American Taxpayer Relief Act (ATRA) into law, increasing taxes for nearly all working Americans. Those in the top tax bracket and those who have to pay capital gains taxes are faced with the largest impact of the new changes.
Under ATRA, the marginal tax rate for high end taxpayers increased from 35 to 39.6 percent, and the tax rate for capital gains and dividend income increased from 15 to 20 percent. Plus, the new Medicare surtax of 3.8% for taxpayers on income over a certain threshold means high end taxpayers are subject to an even higher combined effective federal tax rate.
Section 1042 of the IRC
Fortunately, Section 1042 of the Internal Revenue Code permits business owners who sell a minimum of 30 percent of their company stock to an Employee Stock Ownership Plan (ESOP) to defer federal (and sometime state) taxes due on the transaction. In general, an ESOP is a trust that is established for the benefit of employees. Employees receive an economic interest, but not an ownership interest, in the company via participation in the trust. In return for the sale, selling shareholders may defer federal taxes, and companies may receive tax deductions and exemptions that enhance cash flow. The enhanced cash flow can be retained in the business, or used for capital expenditures, debt repayment, acquisitions, working capital needs or other productive uses that enhance value. It is the ability for selling shareholders to defer income tax dues on the sale of company stock, and the availability of tax deductions and exemptions to corporations that makes the ESOP unique and different than any other corporate shareholder.
Insuring that the tax savings fully inure to the benefit of selling shareholders and the company necessitates an understanding of the statutory requirements to assure compliance. As a result, it is important to seek the help of professionals experienced in negotiating and structuring ownership transition using an ESOP.