Using Estate Planning Techniques to Enhance Tax Savings from an ESOP Transaction

With appropriate planning, an ESOP transaction presents significant opportunities to minimize estate, gift and generation-skipping taxes through the use of such techniques as charitable remainder trusts, grantor retained annuity trusts and irrevocable trusts.  These opportunities can be enhanced through the use of ESOP-related techniques such as warrants with seller-financing or the deferral of capital-gains taxes under Code Section 1042.

  1. Charitable Remainder Trusts: The selling shareholders can give all or part of the Qualified Replacement Property (QRP) purchased in a 1042 transaction to a charitable remainder trust. The selling shareholders receive a return on the gifted property until death or for a term of years, at which time what remains in the trust passes to or for the benefit of the charitable beneficiaries of the trust. The Trust provides steady cash flow to the selling shareholder, while also taking advantage of an income tax deduction for the gift on day one. Furthermore, the remaining value of the Trust will not be subject to federal gift or estate tax when it passes to or for the charities. This technique can also be structured to include benefits to individuals other than the selling shareholders, such as his or her family members.
  2. Grantor Retained Annuity Trusts  (“GRAT”): The selling shareholders can transfer all or part of the QRP to an irrevocable trust called a GRAT, which benefits the selling shareholders and non-charitable beneficiaries, such as their children. The selling shareholders receive annuity payments from the trust for a term selected by each shareholder. At the end of the term, what remains in the trust will pass to their designated beneficiaries. Although in some cases the initial transfer may have utilized a portion of each selling shareholder’s exclusion from federal estate and gift tax, what passes at the end of the term often far exceeds the amount of exclusion used and is not subject to any further federal gift or estate tax or use of exclusion.
  3. Irrevocable Trusts: The selling shareholders can give or sell the QRP to an irrevocable trust without retaining any rights to receive payments from the trust. This technique often results in transfer of significant value to a person’s heirs, including grandchildren and heirs many generations removed from the selling shareholders, with little or sometimes even no payment of gift, estate, or generation-skipping tax or use of exclusion.

Even if a selling shareholder does not take advantage of a Section 1042 transaction, these and other planning techniques can be used to effect transfers of the proceeds from the ESOP sale in a manner that minimizes estate, gift and generation-skipping taxes.

No matter how the ESOP transaction is structured, the transaction presents opportunities for planning that can mitigate tax liability. In order to do so, selling shareholders should consult with trusts and estates advisors who have expertise in these strategies and a working knowledge of ESOP transactions and the opportunities that they present. It is best to engage in this discussion as early as possible, even well in advance of the ESOP transaction, to make sure that selling shareholders’ estate plans are positioned to take advantage of such opportunities.

For More Information

When structuring an ESOP transaction, one of the benefits of working with us is the ability for us to call upon our team of wealth planning, trusts and estates attorneys to work with the selling shareholders to maximize not only the income tax benefits normally associated with an ESOP transaction, but also the estate, gift and generation-skipping tax benefits. Even if you already have a trusts and estates attorney and a comprehensive estate plan, our team of professionals can partner with your team to make sure that you are taking advantage of all available strategies as you evaluate your alternatives.

Our ESOP professionals regularly help business owners recognize tax efficient liquidity and improved tax efficiency of their businesses through an ESOP transaction. As a platform, we have significant experience utilizing estate planning tools, which when combined with an ESOP transaction, can add additional savings for business owners and their families. For example, our estate planning attorneys can develop a plan that permits selling shareholders to transfer warrants related to seller-financing in a manner that avoids federal estate tax on post-transfer appreciation.

If you have any questions regarding this News Alert, please contact Edward C. Renenger at 610.478.2238, Mark B. Russell at 610.478.2166, or the Stevens & Lee attorney with whom you normally consult.

This News Alert has been prepared for informational purposes only and should not be construed as, and does not constitute, legal advice on any specific matter. For more information, please see the disclaimer.