One of the most popular incentives for small business owners to establish an ESOP (employee stock ownership plan) is the ability to defer tax on the gain they will receive in the sale through the Section 1042 deferral. If certain requirements are met (most notably that the ESOP must end up owning at least 30% of the company), the selling shareholders can defer tax on their gain by investing the proceeds in certain types of “qualified replacement property.”

Section 1042 only applies, however, to C corporations. Shareholders in S corporations have not been able to avail themselves of the 1042 deferral. Many companies have gone through the gymnastics to convert to a C corporation before implementing an ESOP, but the process is tricky.

Every time the prospect of retirement reform arises, the ESOP community gets its hopes up that Congress will “fix” 1042 by expanding it cover S corporations. The recent round of legislation again offers hope. There are multiple bills, including the Enhancing American Retirement Now (EARN) Act, passed by the Senate Finance Committee on June 22, 2022, that would open the 1042 deferral opportunity to S corporations. Could it happen, finally? We, and the rest of the ESOP community, will be watching!