plans (ESOPs) and taxation. He specializes in representing
corporations, trustees and selling shareholders in leveraged
transactions involving ESOPs. Mark utilizes his expertise in ERISA and
tax law in order to effectively represent clients in ESOP deals, and
also represents clients in both corporate transactional and employee
benefit matters.
250 Mill Street, Suite 309-311
Rochester, New York 14614
585.512.3414 Phone
mkossow@ESOPPlus.com
www.ESOPPlus.com
tions can sell stock to an employee stock
ownership plan (ESOP) in a tax deferred
"rollover" transaction under Section
1042 of the Internal Revenue Code. As
long as the requirements of the Code
are satisfied, the selling shareholder
can elect to defer capital gains taxes by
reinvesting the proceeds into qualified
replacement property (QRP) securi-
ties of domestic operating corporations.
(Note that securities of international
corporations T-bills or mutual funds will
not qualify as QRP.) Capital gains tax is
deferred until the QRP is sold. However,
if the QPR is held until death, capital
gains are forever eliminated.
For example, if a shareholder sells
at least 30 percent of his or her stock or
at least 30 percent of the value of the
company to an ESOP for $20 million and
elects Code Section 1042 treatment by
reinvesting the proceeds in QRP within
the applicable time period (generally,
12 months from the date of sale), the
million in federal capital gains tax (15
percent of $20 million). This example
assumes that the shareholder's basis
in the stock is zero. Furthermore, the
tax savings can exceed 15 percent if
the shareholder's state and locality also
exempts the sale and reinvestment into
QRP from state capital gains tax. If the
shareholder keeps the QRP until death
and his or her estate disposes of the
QRP, the estate will have no capital gains
tax exposure for the $20 million gain be-
cause under current law the estate takes
the QRP with a stepped up basis equal to
$20 million. If the estate sells the QRP
for an amount in excess of $20 million,
only the excess of the sales price above
the estate's $20 million basis would be
subject to capital gains tax.
Even though using this provision of
the Internal Revenue Code is an excel-
lent way to defer or eliminate capital
gains tax, the shareholder can do even
better by using another technique to re-
maximum estate tax rate is 45 percent.
In the above example, the federal estate
tax will reduce the shareholder's QRP
portfolio from $20 million to only $11
million. Estate taxes will also reduce
future income to Shareholder X's heirs.
A $20 million QRP portfolio earning a
6 percent return would provide annual
income of $1.2 million. After the estate
tax reduces the value of the QRP to $11
million, the $1.2 million income stream
is likewise reduced to $660,000 per
year. This results in a loss of income of
$540,000 per year. Assuming the chil-
dren of the shareholder have a life ex-
pectancy of 30 years, the $540,000 loss
of annual income amounts to an overall
loss of $16.2 million in non-inflation
adjusted dollars.
Under the right circumstances one
technique that can reduce the estate
taxes on the QRP is to have a family
limited partnership (FLP) sell the stock
to the ESOP. In order for this technique
to be utilized, the shareholder must first
contribute his or her stock to the FLP
in a nontaxable exchange for a limited
partnership interest in the FLP. After
the FLP owns the shares, the FLP could
then sell the stock to the ESOP, make a
Code Section 1042 election and reinvest
By Using a Family Limited Partnership to
Sell Closely Held Stock to an ESOP