Failure to file election with return fatal to sec. 1042 deferral.

• Author: Wasserstrum, David J.

Sec. 1042 provides that gain on the sale of qualified securities to an employer stock ownership plan (ESOP) may be deferred. Specifically, and gain on the sale of qualified securities to an ESOP is not recognized to the extent the proceeds from such sale are reinvested in qualified replacement property.

In order to achieve the deferral, all of the following requirements must be met:

1. The taxpayer, or executor of the taxpayer's estate, must elect the deferral provision of Sec. 1042 no later than the extended due date of the return for the tax year during which the sale occurs. Temp. Regs. Sec. 1.1042-1T, Q&A-3 requires the election to be made in a "statement of election" attached to the taxpayer's income tax return filed on or before the due date (including extensions) for the tax year in which the sale occurs. If a taxpayer does not make a timely election, it may not subsequently make an election on an amended return or otherwise. Also, once made, an election is irrevocable.

2. The taxpayer must purchase qualified replacement property within a 15-month period beginning three months before the sale date and ending 12 months thereafter.

3. The taxpayer must sell the qualified securities to an ESOP (or an eligible worker-owned cooperative) that owns, immediately after the sale, at least 30% of each class of outstanding stock of the issuing corporation, or 30% of the value of all the corporation's outstanding stock.

4. The taxpayer's holding period with respect to the qualified securities must be at least three years.

5. The taxpayer must file a verified written statement with the IRS of the employer whose employees are covered by the ESOP (or authorized officer of the cooperative) consenting to the application of Sec. 4978 (tax on disposition of qualified securities by the ESOP).

"Qualified securities" generally means common stock, or certain noncallable preferred stock convertible into common, issued by a domestic corporation that has no stock outstanding tradable on an established securities market. In addition, the securities must not have been received by the taxpayer as a qualified plan distribution or on the exercise of certain stock options.

"Qualified replacement property" generally means any security issued by a domestic corporation (other than the corporation issuing the qualified replacement securities or a member of its controlled group) that does not have passive investment income in excess of 25% of gross receipts.

The deferral is...