New Tax Benefits for Sellers to ESOPs in S Corporations

H.R. 2954 will now go to the Senate. The bill makes two minor improvements for ESOPs as well as a number of other changes aimed at making it easier for employers and employees to assure retirement plans work more effectively. Some of these will affect ESOPs.

Small Tax Deferral for Sale of Stock to an ESOP in an S Corporation Added

Under section 1042 of the tax code, an owner of stock in a non-publicly traded C corporation who sells to an ESOP that owns 30% or more of the stock after the sale can defer capital gains tax by reinvesting in stocks and bonds of U.S. operating companies. For many years, advocates have urged Congress to extend this benefit to owners of S corporations. The new bill would allow these sellers the same benefit, but with a 10% limit on the deferral. So, if an owner has $3 million in gains, $300,000 could be deferred. The change will not be effective until after December 31, 2027.

While it is a very small win for ESOPs, this change to the tax code may make it easier for a future tax bill to expand this percentage.

Change in Definition of Public Company for ESOP Valuation Purposes

ESOP companies listed on stock exchanges do not have to have an annual valuation. There has always been ambiguity over companies that trade over the counter. Section 118 of the bill allows certain non-exchange traded securities to qualify as publicly traded employer securities “so long as the security is subject to priced quotations by at least four dealers on an SEC-regulated interdealer quotation system; is not a penny stock and is not issued by a shell company; and has a public float of at least 10 percent of outstanding shares. For securities issued by domestic corporations, the issuer must publish annual audited financial statements.” The new rule is effective for plan years beginning after December 31, 2026.

Very few ESOPs fall into this category, but some community banks will likely find this new change helpful. ESOPs are common in these companies, and many have shares traded over the counter.