Election of tax-free rollover treatment is optional with the seller. The seller may, if he wishes, elect to be taxed on part or all of the proceeds. Assume, for example, that the ESOP purchases 30% of the outstanding stock from shareholder A for $1 million, and that shareholder A desires to invest $600,000 in stocks and bonds and $400,000 in real estate. In this case (assuming his basis in the stock is zero), $400,000 of the gain will be taxable, and the remaining $600,000 will be tax-free.

By the same token, it is not necessary for the ESOP to acquire 30% ownership if the seller does not desire tax-free rollover treatment. If the seller is willing to pay the tax, he may sell any amount of stock to the ESOP, whether more or less than 30%. To the extent that any sale of stock to an ESOP does not qualify for tax-free rollover treatment, the seller will be taxed at favorable capital gains rates. This is a distinct advantage as compared to a partial stock redemption. A partial stock redemption is usually taxed as a dividend. Dividend distributions are taxed as ordinary income to the shareholder and as a non-deductible distribution of profits by the company.

In certain instances a shareholder may wish to take advantage of tax-free rollover treatment, but may not own the requisite 30%, or may not want to sell 30% by himself. In such cases, it is permissible to aggregate sales from two or more sellers so that the ESOP acquires the requisite 30% ownership. Any aggregate sales, however, must occur simultaneously in order to qualify. If, for example, shareholder A sells a 20% interest on January 1st and shareholder B sells a 10% interest on January 2nd, shareholder B will be eligible for tax-free rollover, but shareholder A will not.

If shareholder B does not wish to sell any shares, shareholder A could still qualify for tax-free rollover treatment by selling a 20% interest and by having the ESOP simultaneously purchase enough treasury stock or newly issued stock to result in 30% ownership of outstanding shares by the ESOP.

It should also be noted that once the ESOP acquires 30% ownership, any subsequent sale of stock to the ESOP will automatically qualify for tax-free rollover treatment.

In order to elect tax-free rollover treatment, a seller must attach a Statement of Election and an Employer Consent form to his personal income tax return. The seller must also execute and have notarized a Statement of Purchase form within 30 days of the purchase of each replacement security. To the extent he has purchased replacement securities prior to filing his personal income tax return for the prior year, he must also attach these Statement of Purchase forms to his income tax returns. To the extent he has not purchased replacement securities by the time of filing of his income tax return, he must attach such Statement of Purchase forms to his next year's income tax return.

A seller may buy and sell securities during the 12 month election period. However, once a seller uses part or all of the sale proceeds to purchase "replacement securities," he cannot later change his mind and designate other securities as the replacement securities.

One additional requirement of the tax-free rollover provision is the requirement that none of the stock acquired by the ESOP in a rollover transaction may be allocated to the seller (or his family), or to anyone who owns (together with his family) more than 25% of the outstanding stock of the company. For purposes of this rule, the seller's family includes his spouse, brothers, sisters, ancestors and lineal descendants. In the case of a more than 25% shareholder, the family includes only his spouse, and his children, grandchildren and parents. Any stock allocated to a participant's account under the ESOP is also counted in determining whether such individual is a more than 25% shareholder.

If a seller elects tax-free rollover treatment with respect to part or all of the sale proceeds, then he (and his family) is not counted as part of the eligible payroll, and is not eligible to receive allocations under the ESOP. By the same token, if a shareholder (and his family) owns more than 25% of the outstanding stock at the time of the transaction, or subsequently becomes a more than 25% shareholder (by virtue of his participation in the ESOP or otherwise), then he (and his family) is no longer eligible to receive allocations under the ESOP.

There is an exception, however, for lineal descendants of the seller. Under this exception, the lineal descendants as a group may receive allocations of up to 5% of the stock purchased from the seller.

It should be especially noted that any loss of plan benefits by the seller or by a more than 25% shareholder, or by any related parties, can be "made up" by adopting a Supplementary Executive Retirement Plan (SERP) for the affected parties.

Under a SERP, the company simply sets aside each year a number of shares equal to the number of shares the affected individual would have gotten under the ESOP. The company then distributes the cash value of these shares to the affected individual at the same time and in the same manner as he would have otherwise received it under the ESOP.

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