Friday March 29, 2024

4.6.7 ESOPs and Qualified Replacement Property

ESOPs and Qualified Replacement Property

Employee Stock Ownership Plan (ESOP):  A business owner who has held stock for three or more years may sell the stock to an employee stock ownership plan (ESOP) and acquire qualified replacement property (QRP).

Employee Stock Ownership Plan (ESOP)


A business owner who has held stock for three or more years may sell the stock to an employee stock ownership plan (ESOP) and acquire qualified replacement property (QRP). The ESOP must hold 30% or more of the stock after the sale. The QRP may include public stocks and bonds in an operating corporation. Sec. 1042(c)(4).

Most business owners have little or no basis in the stock of their businesses. Since the QRP takes the basis of the owner's stock, it frequently has virtually no basis. Therefore, this public stock is an excellent candidate for a charitable remainder unitrust. The holder of QRP may transfer the public securities to a charitable remainder unitrust, bypass gain and receive a charitable deduction. PLR 9732023.

Example 4.6.7A QRP to a Unitrust

Joe and Susan Wilson decide to cash out the majority of their equity in their family business. Joe and Susan hold C corporation shares. Since they have 30 employees, they create an ESOP. Then they sell 50% of their shares to the ESOP. After the sale to the ESOP, Joe and Susan transfer the cash proceeds into QRP consisting of stocks and bonds of publicly traded operating corporations.

Joe and Susan now desire to diversify some of their public securities. They transfer $200,000 worth of their QRP stock into a charitable remainder unitrust for two lives. The 6% unitrust enables them to bypass capital gain on the sale of stock and receive an income tax deduction of over $82,000.

Case Studies on ESOPs and Qualified Replacement Property

A Real Life Story from ESOPs Fables:   Fred Johnson, age 58, is the sole shareholder in a closely held C corporation that remanufactures and distributes used computers. The company was established in 1985 and due to Fred's hard work, ingenuity and foresight, has grown from a garage-based operation into a very successful corporation that nets over $500,000 annually.

Another Tale from ESOP's Fables, Part I:   Eric and Stephanie Hawkins, both age 50, have decided that they are tired of the fast-paced lifestyle of running a small business. They started their Seattle printing business, Speedy Printing, Inc., just after they were married 20 years ago. It has now blossomed into a multiple-location, 50-employee company netting over $350,000 annually. The printing business is currently structured as a C corporation and Eric and Stephanie own 100% of the stock. Their CPA stated that their stock is probably worth well over $5,000,000.

Another Tale from ESOPs Fables, Part II:   In Part I, we were introduced to Eric and Stephanie Hawkins, who are the sole shareholders in a Seattle printing business. They are looking to divest themselves of ownership in the company and transfer shares of stock to their employees through an employee stock ownership plan (ESOP). One of their major goals is to transition away from the fast-paced lifestyle of owning a business and spend more time with each other and their two children. Their dream has been to own a bed and breakfast and they have taken a major step in this direction by purchasing a five-acre parcel of property on San Juan Island.

Private Letter Rulings

PLR 199919039 ESOP Stock to Living Unitrust:   As a result of a merger, the President of Corporation A transferred his stock in qualified Plan X into Plan Y with B Corporation. His stock would (i) be transferred in part to a rollover IRA, (ii) be distributed and transferred to a charitable remainder unitrust and, (iii) be distributed in part in a lump sum distribution to him. The Service determined that the basis in the stock would be taxable, but the stock could then be transferred to a unitrust, with bypass of gain on the appreciation and a 30% type income tax deduction.

PLR 9533038 Gift of QRP to Charity:   Some business owners have entered into attractive transactions with an employee stock ownership plan (ESOP). Under this concept, the owner transfers a significant portion of his or her stock to the ESOP. If the donor complies with the required rules as to minimum transfer amount and other qualifications, then he or she may take the proceeds from the sale of personally held company stock to the ESOP and use these proceeds to acquire public securities. The public securities are termed qualified replacement property (QRP) under Sec. 1042 of the Code and gain will be deferred until sale of the stock. Since the owner typically has virtually no basis in the company stock, he or she also has little or no basis in the QRP. Thus, it is attractive to consider the transfer of QRP to a charity. In this ruling, the Service noted that it is possible to transfer QRP to a charity and not cause any recapture of gain. In addition, the holding period of QRP includes the prior holding period of the company stock. Thus, it appears that, immediately after the receipt of QRP, it may be transferred outright to a qualified charity.


PLR 9732023 ESOP/QRP Funds Unitrust:   The taxpayers requested guidance on the federal income tax consequences of establishing a charitable remainder unitrust and contributing qualified replacement property (QRP) to the charitable trust. The donors sold shares of their closely held corporation stock to an employee stock ownership program (ESOP). The proceeds from the stock sale were reinvested in QRP as provided under Sec. 1042 of the Code. A portion of the QRP was transferred to the charitable trust. The Service ruled that no gain would be realized on the transfer of the QRP to the charitable trust. Accordingly, contributing of the QRP to the charitable trust would not cause a recapture of the gain deferred on the sale to the ESOP.


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