What is a tax-free ESOP rollover? - ESOP Taxation
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What is a tax-free ESOP rollover?

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A tax benefit of selling to an ESOP: Shareholders who sell their stock to an ESOP can elect to defer federal income taxes on the gain from the sale, if the sale qualifies as a tax-free rollover under Section 1042 of the Code.

In order to qualify for the rollover:

  • The ESOP must own at least 30 percent of the companys stock
  • The proceeds must be reinvested in Qualified Replacement Property
  • The stock sold to the ESOP must be common stock with the greatest voting power and dividend rights
  • The stock sold to the ESOP must have been acquired as an investment and not in an employment-related transfer
  • The seller must have owned the stock being sold for at least three years
  • The company is not an S corporation

Other things to note about the tax-free ESOP rollover:

  • The selling shareholder, any 25% or greater shareholder, and certain family members, are generally prohibited from receiving allocations of stock acquired through a tax-free ESOP rollover.
  • A shareholder may elect to roll over all or any portion of the ESOP sale proceeds. The election must be filed with the selling shareholders federal income tax return.
  • The company must agree to pay a penalty tax if the ESOP shares acquired through the rollover are sold or disposed of by the ESOP within three years after the date of sale.

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