New Tax Rules Could Make ESOPs More Attractive

Starting in 2013, business owners selling their companies will face significantly higher taxes on the sale proceeds. Appropriately structured sales to ESOPs allow sellers to defer capital gains taxes, and higher rates will make that deferral more valuable.

Under the American Taxpayer Relief Act of 2012 (the "fiscal cliff" legislation signed on January 2, 2013), capital gains tax rates will rise from 15% to 20% for single filers with incomes of more than $400,000 and joint filers with incomes of more than $450,000, which would include most sellers. In addition, under the Health Care and Education Reconciliation Act of 2010, as of 2013 an additional 3.8% Medicare surtax will be imposed on certain investment income received by high-income filers.

A more complex effect arises from the so-called "Pease" limit, which, as revived under the American Taxpayer Relief Act, reduces itemized deductions by 3% of the amount of adjusted gross income of $250,000 for single filers and $300,000 for joint filers. The overall reduction in itemized deductions cannot exceed 80%. It is estimated this could add another 1% to tax costs, meaning just at the federal levels the total taxes could be as high as 24.8%. State taxes are in addition to this. In California, state taxes could be as high as an additional 10.3%.