Selling to an ESOP in 2012 Increases After-Tax Proceeds by 43%
When a business is sold to a third party, the buyer generally prefers to purchase a company’s assets rather than its stock for liability and tax reasons. Selling to an ESOP is always a stock sale which is 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 (currently at a historically low 2012 long-term capital gains tax rate of 15%). The more common sale alternative, the asset sale, is generally taxed at the higher ordinary income rate (the top ordinary income tax rate is currently 35%).
[While there is an alternative ESOP sale that allows the seller to Defer Taxation in an ESOP Section 1042 Sale, many sellers are currently opting to lock in the historically low 2012 long-term capital gains tax rate of 15%.]
On January 1, 2013 the “Bush tax rates” are scheduled to expire. As a result the long-term capital gains rate will increase from 15% to 20%. In addition, a New 3.8% Medicare Tax on Unearned Income as a result of the Health Care and Education Reconciliation Act of 2010 is effective on January 1, 2013. This puts the 2013 net effective long-term capital gains tax rate at 23.8% and amounts to a 59% increase in capital gains taxes.
Another way to look at the numbers: All other factors being the same, selling to an ESOP in 2012 could increase your overall after-tax sale proceeds by 43% compared to an asset sale in 2013. Even if you are set on selling to an ESOP but not sure about the timing, selling to an ESOP in 2012 could increase your overall after-tax sale proceeds by 12% compare to selling to an ESOP in 2013.
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2012 ESOP Stock Sale
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2013 ESOP Stock Sale
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2012 Non-ESOP Asset Sale
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2013 Non-ESOP Asset Sale
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Sale Price
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$1,000,000
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$1,000,000
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$1,000,000
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$1,000,000
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Tax Rate
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15%
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23.8%
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35%
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40.5% *
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After-Tax Proceeds
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$850,000
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$762,000
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$650,000
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$595,000
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Additional After-Tax Proceeds Compared to 2013 Asset Sale
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43%
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28%
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9%
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-
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* This includes the increase in the highest ordinary income tax bracket from 35% to 39.6% and the New .9% Medicare Tax on Earned Income. Both increases are effective January 1, 2013.
This analysis assumes the company is an S Corporation and uses the tax rates in effect and scheduled as of the original date of this article (May 22, 2012). It also assumes that all of the gain of an asset sale will be taxed at ordinary income rates. It does not contemplate STATE INCOME TAXATION, which could make a 2012 ESOP stock sale even more favorable.
Here are some additional benefits of Selling to an ESOP: