Business Exit Strategy: Increase After-Tax Proceeds With an ESOP

Posted by Aaron Juckett, CPA, CPC, QPA, QKA on Tue, Feb 12, 2013
Find me on:

increase after tax proceeds with esopWhen a business is sold to a third party, the buyer generally prefers to purchase a company’s assets rather than its stock, whereas the seller would rather sell the stock. The decision of asset sale or stock sale is often subject to the negotiation process and is an important consideration when developing your business exit strategy.

A very powerful benefit of incorporating an ESOP in your business exit strategy is that an ESOP transaction is always a stock sale, which is generally more favorable from a tax standpoint than a traditional asset sale. 

When analyzing the purchase price, it is essential to consider the after-tax proceeds when comparing an ESOP transaction sale to a third party sale.

In a stock sale, the seller is generally eligible for long-term capital gain treatment at the current long-term capital gains rate.  The top capital gains rate is currently 20% plus the additional 3.8% Medicare Tax on Unearned Income above a certain threshold as a result of the Health Care and Education Reconciliation Act of 2010.  

The more common third party sale alternative, the asset sale, some or all of the sales proceeds are generally taxed at the higher ordinary income rate.  The top ordinary income tax rate is currently 39.6% plus the additional 0.9% FICA tax above a certain threshold as a result of the Health Care and Education Reconciliation Act of 2010.  

If a sale involves a C Corporation, a stock sale to an ESOP may offer you additional tax savings.  A C Corporation asset sale may be subject to double taxation since the company pays taxes on the gain on the sale of the asset, and in addition, the seller pays taxes when a dividend is subsequently paid.

There is an alternative ESOP sale, the Section 1042 Sale to an ESOP, which allows the seller to defer or avoid altogether the taxation on the sale to an ESOP.

The following chart compares the after-tax proceeds of a company sale under the three approaches discussed above:

 

ESOP Stock Sale (Section 1042)

ESOP Stock Sale
(non-Sec 1042)

Third Party Sale

 Gross Sale Proceeds

$1,000,000 

$1,000,000 

$1,000,000 

 Federal Income Taxes

(200,000) 

(396,000) 

 After-Tax Sale Proceeds *

$1,000,000 

$800,000 

$604,000 

 Additional After-Tax Proceeds  Compared to 2013 Asset Sale (%)

66% 

32% 

* There are additional ways to increase the after-tax proceeds in a sale to an ESOP, including additional tax deductions, Receiving Full Payment at Fair Market Value, Obtaining Additional Value for the Seller via ESOP Participation and Synthetic Equity, and Selling to an ESOP Obtaining a 10-15%+ Rate of Return on seller financed amounts, if any.  Including these additional after-tax proceeds in the analysis would further increase the additional after-tax proceeds available in a sale to an ESOP.

The above analysis does NOT contemplate STATE INCOME TAXATION.  It also assumes the top individual tax bracket but does NOT contemplate the impact of the additional 3.8% Medicare Tax above a certain threshold and/or the 0.9% FICA Tax above a certain threshold.

Benefits of an ESOP as Business Exit Strategy eBook

  

 

Image Credit

Topics: ESOP Benefits, Employee Stock Ownership Plan (ESOP), Business Exit Strategy

Aaron Juckett, CPA, CPC, QPA, QKA
Written by Aaron Juckett, CPA, CPC, QPA, QKA

Aaron is President and Founder of ESOP Partners and provides implementation, administration, and consulting services to hundreds of companies. He is a member of The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO).

Keep Your ESOP On Track and On Time
12 Benefits of Incorporating an ESOP in your Business Exit Strategy

Recent Posts