Obama Budget Tax Proposals Could Help ESOP Formation

President Obama's budget proposal would reinstate capital gains rates at 20% in 2011, up from 15% currently. The proposal would only affect individuals with $200,000 in income or families with $250,000. That could make ESOPs relatively more attractive as a way to sell a closely held company because sellers can defer capital gains taxes by reinvesting in other companies if they meet basic qualification rules.

Individual income tax rates would also rise back to the levels where they were before "temporarily" being cut in 2001 (in a bizarre bit of budgeting legerdemain, several tax cuts were made with a sunset provision to keep the budget at a lower projected deficit, although the expectation was the cuts would, in fact, be kept). The 33% individual bracket would become 36%. And the 35% bracket would rise to 39.6%. This would make it more appealing to be an S corporation ESOP because S earnings are taxed at personal tax rates. To the extent an ESOP is an owner of an S corporation, that percentage of its profits is not subject to corporate income taxes.

The budget also would eliminate the already reduced capital gains tax rates for new investments in small business (under $50 million in revenue) that are held for five years or more. This would probably have a minimal effect on ESOPs, however, as most of these businesses would not be sold for a long time.