Taxes and Business Decisions 343must offer to buy back the distributed shares at fair market value. As a practi-
cal matter, most employees will accept such an offer rather than moving into
retirement with illiquid, closely held company stock.
If Morris accepts these arguments and opts for an ESOP buyout, the
following benefits accrue. Rather than being able to deduct only the interest
portion of its payments to the bank, the corporation may now contribute the
full amount of such payment to the plan as a fully deductible contribution to
a qualified plan. The plan then for wards it to the bank as a payment of its
obligation.
Furthermore, the Code allows an individual who sells stock of a corpora-
tion to the corporation’s ESOP to defer paying any tax on the proceeds of such
sale, if the proceeds are rolled over into purchases of securities. No tax is then
paid until the purchased securities are ultimately resold. Thus, if Morris takes
the money received from the ESOP and invests it in the stock market, he pays
no tax until and unless he sells any of these securities, and then only on those
sold. In fact, if Morris purchases such securities and holds them until his death
(assuming he dies prior to 2010), his estate will receive a step-up in basis for
such securities and thus will avoid income tax on the proceeds of his company
stock entirely (see Exhibit 11.7).
ESTATE PLANNING
Should Morris rebel at the thought of retiring from the company, his thoughts
may naturally turn to the tax consequences of his remaining employed by the
company in some capacity until his death. Morris’s lifelong efforts have made
him a rather wealthy man, and he knows that the government will be looking
to reap a rather large harvest from those efforts upon his death. He would no
doubt be rather disheartened to learn that after a $675,000 exemption (which
increases to as much as $3.5 million in 2009), the federal government will re-
ceive 37% to any where from 45% to 55% of the excess upon his death, de-
pending upon the year in which he dies. Proper estate planning can double the
amount of that grace amount by using the exemptions of both Morris and his
wife, but the amount above the exemptions appears to be at significant risk. It
should further be noted that the federal estate tax is currently scheduled for re-
peal in 2010, but, under current law, will be reinstated in 2011.
EXHIBIT 11.7 Corporate redemption versus ESOP
purchase.
Corporate Redemption ESOP Purchase
Only interest deductible Principal and interest deductible
Capital gain Gain deferred if proceeds rolled over