As a business owner or financial executive, you are probably paying close attention as President-elect Donald Trump prepares to take office and Republicans look to control both chambers of Congress. If you are considering a sale to an employee stock ownership plan (ESOP)—or are already managing an ESOP-owned company—you may be wondering about the effect of potential changes in current tax policy, including corporate tax rates, capital gains taxation, estate taxes, and Section 199A deductions.
Tax policies nearly always have significant implications for ESOPs, shaping decision-making for companies contemplating an ESOP transaction and influencing the financial landscape for existing ESOP-owned businesses. Understanding the proposed tax policy shifts under the incoming administration and how to navigate the possible impacts, from tax rate changes to exemptions and deductions, will help you anticipate and plan for any changes on the horizon.
Let’s delve into how the new Trump administration might reshape the tax landscape for ESOPs.
Current Tax Rates May Continue
The Tax Cuts and Jobs Act of 2017 (TCJA), enacted under the previous Trump administration, reduced the corporate tax rate from 35% to 21%. Upon returning to the White House, Trump plans to continue this theme by extending the TCJA—and potentially even lowering the corporate tax rate from 21% to 15%, with the goal of boosting business investment by increasing after-tax profits.
Potential Impact on ESOPs
Lower corporate tax rates generally increase a company’s after-tax income, which can enhance the value of ESOP shares. For owners of an ESOP business operating under a C corporation structure, the reduced tax burden could increase your company’s profitability and cash flow, which is particularly crucial if you are preparing to finance the purchase of shares. If your business operates as an S corp, however, you’ll see little impact, as a flow-through entity wouldn’t pay corporate tax rates.
Are you an ESOP-owned company that is not 100% ESOP? If so, you could still benefit from the lower tax rate, which can lead to higher contributions to employee accounts and potentially more rapid repayment of any debt incurred from the ESOP transaction. And if you’re considering the 1042 election in an ESOP transaction, the option to convert to a C corp may become less appealing from a shareholder perspective, as lower corporate tax rates make this choice less advantageous regarding the capital gains tax deferral on the sale of shares to the ESOP.
Whether you are a C corp, an S corp, or an existing ESOP-owned company, a favorable shift in the valuation landscape is expected. The inherent tax shield from interest expenses factored into cash flow calculations available to investors is likely to enhance overall valuations, particularly for transactions involving ESOP implementations, which frequently rely on discounted cash flow analysis. This embedded tax advantage can provide a significant boost to valuations in these scenarios.
Preferential Rates May Be Extended
The TCJA did not significantly alter capital gains taxes, and long-term capital gains remained taxed at preferential rates of 0%, 15%, or 20%, depending on your income level. Trump is expected to support a 15% maximum capital gains tax rate, which would favor business owners selling their companies, including to an ESOP, by minimizing the tax burden on the sale proceeds.
Potential Impact on ESOPs
Looking ahead, a 15% maximum capital gains rate could further enhance deal flow by making sales more tax-efficient. For ESOP transactions specifically, however, lower capital gains rates could reduce the comparative appeal, as higher rates generally amplify the tax advantages of ESOP-specific strategies like Section 1042 deferral. In a lower capital gains environment, an ESOP may not stand out as the preferred exit strategy as strongly as they would with higher rates.
Temporary Policy Could Become Permanent
The TCJA doubled the estate tax exemption to an all-time high of $13.6 million per individual in 2024, reducing the number of estates subject to federal taxes and decreasing the urgency of selling to an ESOP for estate planning purposes. Although the estate tax exemption is set to sunset on January 1, 2026, and is scheduled to scale back to the $5 million pre-TCJA amount (indexed for inflation after 2025), Trump and a Republican Congress are expected to extend or make permanent these provisions.
Potential Impact on ESOPs
The potential stability of a continued estate tax exemption may reduce the pressure on anyone considering an ESOP sale as a means of estate planning. But tax laws are subject to change with shifts in political leadership and policy priorities; an extended exemption today does not guarantee permanence, and future administrations may alter estate tax thresholds again. Proactive planning ensures you will be prepared for such changes.
Deductions Are Unlikely to Expire
The Section 199A deduction is a provision introduced under the TCJA that allows owners of pass-through businesses—such as sole proprietorships, partnerships, and S corporations—to deduct up to 20% of their qualified business income (QBI) from their taxable income. Although it is set to expire at the end of 2025, President-elect Trump has expressed support for extending the Section 199A deduction or making it permanent, thereby continuing the benefits for pass-through business owners beyond the current expiration date.
Potential Impact on ESOPs
If you’re an S corp business owner considering an ESOP sale, the Section 199A deduction offers valuable benefits that are likely to continue into the near future and possibly beyond, thanks to prioritization by the incoming administration. Your business is a pass-through entity, with income flowing directly to shareholders, who then report it on their personal tax returns. With the Section 199A deduction, these shareholders can deduct up to 20% of their QBI (subject to limitations), reducing their overall personal tax burden (as they are not a specified service, trade, or business). Additionally, your S corporation, unlike a C corporation, is not subject to corporate-level taxes. This “tax-free” status at the entity level means more of your company’s profits are retained within the business, which can improve cash flow, enhance business value, and better position your company for financing the ESOP transaction.
If your business currently operates as a C corporation, consider converting to an S corporation before the ESOP sale to take advantage of this deduction and other tax efficiencies associated with S corp status. Transitioning to an S corp and utilizing the 199A deduction can provide you with a tax-advantaged setup that boosts both personal and business-level savings.
Anticipated tax policy shifts under the new administration starting in 2025 do not specifically favor ESOPs over other options, but they are likely to boost transaction volumes across various ownership transition structures, including ESOPs. If you’re considering an ESOP transaction, lower corporate and capital gains taxes and an extended estate tax exemption can deliver increased financial flexibility and profitability, making your ownership transition more appealing overall. And if your company operates as an S corporation, the potential permanence of the Section 199A deduction could further enhance your cash flow and reduce your tax burdens.
Politics can be fickle, however, and passing tax legislation may require bipartisan compromise even in a Republican-controlled Senate; cooperation between parties is essential, and final outcomes remain uncertain until laws are enacted. Nevertheless, the promise of a favorable environment for business owners may leave you with valuable tools to maximize value and preserve wealth—positioning ESOPs as a strategic choice for your business, aligned with the incoming administration’s tax-focused goals.
Schedule a consultation with our experts to ensure your business is positioned for success in 2024 and beyond.