An Employee Ownership Trust is taxed differently from an ESOP. It does not give the selling owner the Section 1042 capital-gains deferral that selling to an ESOP or worker cooperative can, so the owner is generally taxed on the gain in the normal way. The company can deduct the profit-sharing it distributes, and employees are taxed on it as ordinary income, like a bonus. Confirm with a CPA or tax attorney.
The tax treatment of an Employee Ownership Trust (EOT) is one of the most important and most misunderstood parts of the structure, and it differs meaningfully from an ESOP.
For the selling owner:
- An EOT does not offer the Section 1042 capital-gains tax deferral that is available when selling to an ESOP or a worker cooperative. The owner is generally taxed on the gain from the sale under the normal rules. (The US has no EOT-specific capital-gains break for the seller; the UK does, so do not assume UK treatment carries over.)
- This is a deliberate trade-off: the EOT avoids the cost and complexity of an ESOP but gives up that specific deferral.
For the business and employees:
- The company can generally take a tax deduction for the profit-sharing it distributes to employees through the trust.
- That profit-sharing is typically taxed to employees as ordinary income, the same way a bonus is — subject to payroll taxes and reported on the W-2 in the year received.
Why this matters: owners weighing an EOT against an ESOP should run the numbers on both. The ESOP's tax advantages can be significant (a 100%-ESOP-owned S corporation pays no federal income tax on the ESOP-owned profits, with no EOT equivalent), but so are its costs. The EOT trades the deferral for a simpler, cheaper structure.
Entity type also shapes the answer. For an EOT, S-corporation shares realistically have to sit in a grantor trust (the other trust types that can hold S-corp stock do not fit a broad employee-ownership trust), so the founder may keep paying income tax on company income even after giving up the economics; a non-grantor EOT that stands on its own tax footing generally cannot keep S status and may need to convert to a C corporation.
Tax outcomes depend on your entity type, your basis in the company, the deal structure, and current law, all of which change. Do not rely on this as tax advice — confirm your specific situation with a CPA or tax attorney experienced in employee-ownership transitions.