Disposing of a Business
Using an
ESOP (Employee Stock Ownership Plan)
In order to sell your business and avoid as much tax as
possible, here’s an interesting idea for your consideration. A special provision in
the tax code that is meant to foster employee ownership allows you to sell 30% or more of
the stock in your company to an employee stock ownership plan (called an ESOP) without
owing any immediate tax on your profit. (You must have held the stock for at least three
years.) All you have to do to avoid tax is to reinvest the sale proceeds in the securities
of U.S. operating corporations. You can’t buy mutual funds; you must buy securities
issued by other corporations. However, you can diversify as much as you want. If
you’re looking for current income, you can buy bonds or dividend paying stock. If
you’re looking for future appreciation, you can buy growth stock. It’s up to
you.
You only owe tax when and if you sell the replacement
securities. If you hold them for your entire life, neither you nor your heirs will ever
owe income tax on them.
How do you go about this? You have to set up an ESOP for
your company. An ESOP is actually a qualified plan for the benefit of your employees. Your
company makes contributions to the plan, just as it would with any other retirement plan.
The difference is that the tax-deductible contributions go toward the purchase of stock
from you (or to pay off the tax-advantaged loan that the company of the ESOP may take out
to buy the shares).
Of course, there are costs involved. You may have to
terminate or modify an existing retirement plan. The ESOP rules are quite complicated, and
there will be appraisal costs to ensure that the ESOP is paying a fair price for your
shares. But if your investment in your company is relatively small, and its value is
greatly appreciated, the combination of tax advantages offered by the ESOP will more than
make up for the expenses.
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