Socialism: count the old capital gains break on buyouts against the buyout track

Co-Authored-By: Claude Opus 5.5 <[email protected]>
Claude-Session: https://claude.ai/code/session_01QWPs69B8nQZjtPEUXMKzZx

JoshHeaps.Net/Content/Socialism/buyouts.md

@@ -45,12 +45,42 @@ So should [the bank](the-bank.md) lend for these sales? This page's answer is **
 
 - **Only healthy businesses.** At least three years of profits, with the latest year audited by an outside accountant and every year matching the tax returns. Sales to the seller's own other businesses or relatives don't count toward those profits. The seller must have owned the business for at least three years, and it can't be in bankruptcy or behind on taxes. Rescues stay out, as they do for [the rest of the pilot](pilot-spec.md#who-can-borrow).
 - **The owner starts it, in writing.** The bank never approaches an owner, and neither do the advisers or groups the pilot pays. The owner can back out at any time before closing.
-- **No new tax break.** American law already lets some owners put off capital gains tax when they sell to an ESOP or a worker co-op. It applies to one kind of corporation (a "C corporation"), requires the workers to end up owning at least 30%, and requires the seller to reinvest the money in other American companies ([26 U.S.C. § 1042](https://www.law.cornell.edu/uscode/text/26/1042)). This model leaves that rule alone and adds nothing to it. The bank's only offer is that it will lend. That keeps out most owners who are only after a tax deal, and it keeps the cost to the public from growing the way Britain's did.
+- **No new tax break.** The bank's only offer is that it will lend. That keeps out most owners who are only after a tax deal, and it keeps the cost to the public from growing the way Britain's did. An old tax break already covers some of these sales. The model leaves it alone, but counts its cost against the track ([below](#the-tax-break-that-already-exists)).
 - **Private lenders go first.** The bank lends alongside a private or community lender, such as a bank, a credit union or a community development lender like the co-op loan funds, that takes at least a quarter of the main loan, on the same terms and in the same place in line. That's demanding, and it's meant to be. In the conversions Project Equity reviewed in 2017, the main loan was usually shared among several lenders, often led by a small co-op loan fund, and some bigger lenders would join only in the safest, first-paid slice of the larger deals ([Project Equity, 2017](https://www.project-equity.org/wp-content/uploads/2023/06/Addressing-the-Risk-Capital-Gap-for-Worker-Coop-Conversions_Strategies-for-the-Field_Project-Equity.pdf)). The bank won't take the riskier slice behind a private lender, because that would put the public's money where the private money should be.
 - **The private quarter has to be really private.** It counts only as far as the lender keeps it at risk: not guaranteed or bought in part by a state or federal program, and not sold on, for the whole life of the loan, certified each year. Only new money counts, so a seller's existing lender can't join at a quarter while the sale pays off its old, bigger loan. A lender funded by the bank itself doesn't count. Every lender says in the deal file where its own money comes from, and the bank reports each year how much of the private share came from ordinary banks and credit unions and how much from mission lenders, some of which are partly funded by public programs or charities.
 - **The lenders share alike.** A written agreement among the lenders, published with the deal, splits fees, collateral and any early repayment in proportion. The bank or a neutral party manages the loan, so the private lender can't collect first or push a piecemeal sale that suits it, and every step in a default follows [the lock](the-lock.md).
 - **When no private lender will join.** The bank can lend alone only after two lenders with no ties to the deal have turned down an equal quarter share on the standard form, naming the terms they would have accepted. Deals the bank makes alone are reported separately, with their own loss rate, and can't be more than a third of the track's loan money. If that cap is reached, the bank stops lending alone and says so. The bank expects many deals to need it, because an equal place in line is a strict rule. A high share of solo deals would say more about how strict the rule is than about whether the co-ops can pay. If private lenders join almost every deal, that's a sign the bank isn't needed for buyouts, and the results will show that too.
 
+### The tax break that already exists
+
+Since 1984, federal law has let an owner put off capital gains tax on selling a company's shares to an ESOP or a worker co-op ([26 U.S.C. § 1042](https://www.law.cornell.edu/uscode/text/26/1042)). The rules:
+
+- **The company** has to be an ordinary "C corporation" whose shares aren't publicly traded, and the sale has to be of its shares, not its assets.
+- **The seller** has to have held the shares for three years, and the co-op has to own at least 30% of the company right after the sale.
+- **The money** has to be reinvested in shares or bonds of other American operating companies, between three months before the sale and a year after it. Only the part reinvested in that window is covered.
+- **The tax** comes due when the seller sells that replacement investment. Giving it away doesn't trigger the tax. If they hold it until they die, their heirs inherit it at its value then, and the tax is never paid. Sellers commonly buy long-term bonds as the replacement and borrow against them, so they get the cash without the tax ([CSG Partners, 2023](https://www.csgpartners.com/esop-resources-news/1042-rollovers-capital-gains-taxes-esop); [26 U.S.C. § 1014](https://www.law.cornell.edu/uscode/text/26/1014)).
+
+**The limit to C corporations is weaker than it looks.** An owner of an S corporation, the more common kind among small companies, can drop that status before the sale, even the day before ([Wiener, 2021](https://jrwiener.com/updated-section-1042-tax-benefits/)). The cost is waiting five years to switch back ([NCEO](https://www.nceo.org/employee-ownership-faq/who-qualifies-for-the-section-1042-tax-deferral-esop)), and a locked co-op is a C corporation anyway ([How a Locked Co-op Is Taxed](taxes.md)).
+
+**It has barely been used for co-ops.** A guide for owners posted in 2011 said that "as far as the we can determine, that provision has never been used" for co-ops, though sales to ESOPs use it routinely ([Britton & Stewart, NoBAWC](https://nobawc.org/wp-content/uploads/2011/11/Selling-to-Your-Employees-through-a-Worker-Cooperative.pdf)). That's old and hedged, and nobody seems to have counted since. The authors think a company can turn itself into a co-op and buy back the owner's shares, and still count as a sale to a co-op. That hasn't been tested either. A bank that lends for co-op buyouts could make the break far more common, and that makes its cost part of what the track costs.
+
+**The co-op takes on risks too.** To give the seller the break, the co-op has to sign a statement agreeing to two federal penalty taxes (§ 1042(b)(3)):
+
+- **10% of the sale price** if it sells the shares it bought within three years and its holding falls ([§ 4978](https://www.law.cornell.edu/uscode/text/26/4978)). A forced sale after a default in those years could trigger it.
+- **50%** if any of those shares, or the benefit of them, goes to the seller, their relatives or anyone owning a quarter of the company ([§ 4979A](https://www.law.cornell.edu/uscode/text/26/4979A)). A seller or relative who works there can still be a member on the same terms as anyone else, but shouldn't get any of the shares the seller sold ([Britton & Stewart](https://nobawc.org/wp-content/uploads/2011/11/Selling-to-Your-Employees-through-a-Worker-Cooperative.pdf)). How that fits with members' capital accounts is a question for each co-op's lawyer.
+
+A share sale also brings every old debt and lawsuit of the company along, and the co-op doesn't get the higher tax value on its equipment that buying the assets would give it, which means more tax later.
+
+**What the model does about it:**
+
+- **It doesn't forbid it, or reward it.** The model doesn't change tax law in either direction. The bank can't refuse or reprice a deal because the seller takes the break, or because they don't.
+- **The co-op decides with its own lawyer.** Before it signs the statement, the co-op gets written advice from its own lawyer on the penalty taxes and the share-sale risks, paid from the help budget. Any penalty tax the co-op owes because of the seller's break comes out of the seller's paid-last share first. The co-op can sign only at closing, with a copy to the bank. Signing later without telling the bank breaks the loan terms.
+- **The seller proves it.** A seller who takes the break sends copies of the election and the proof of reinvestment within 15 months of the sale. Part of their paid-last share is held back until they arrive. The reviewer checks them.
+- **It's counted as tax not collected, in the pass test.** The cost is the federal tax the seller would have owed on the sale without the election, at the seller's own rate, leaving out gain another rule already excuses, such as the small-business stock exclusion ([§ 1202](https://www.law.cornell.edu/uscode/text/26/1202)). It's counted as never paid. It goes into the track's [money test](#why-a-separate-track) like any other cost, because the track is what makes it happen. Lost state tax is reported beside it but not counted, since it isn't federal money.
+- **The deal file shows it next to the price.** Workers and their advisers see what the seller's tax saving is worth before the vote. They can bargain over it. The model doesn't set a split. It's also in the seller's line in [Where the money went](#who-buyouts-are-compared-against).
+
+**How big it could be.** Take the track's typical $2.5 million sale, where about $2 million is paid at closing and the rest through [the seller's share](#the-seller-shares-the-risk). If the owner started the business, nearly all of the price is gain. At the top rate of 23.8% (20% capital gains plus the 3.8% investment income tax), the tax put off on the closing money is about $475,000. It's up to about $600,000 if the seller reinvests other money to cover the rest. That's a third or more of the bank's roughly $1.5 million loan. If every one of 50 to 60 deals used it, that's roughly $25 million to $35 million, a quarter or more of the track's money. If many sellers take the break, the track will probably fail its money test. That's the honest answer to whether these buyouts paid the public back. Nobody knows how many will take it, because almost nobody has.
+
 ### A fair price
 
 - **Appraisers come from a panel, in rotation.** An independent appraiser, drawn in turn from a panel the bank keeps and paid by the bank, values the business under standard professional rules. The value is what the business is worth on its own, to a buyer who'll run it as it is. It doesn't include the premium a competitor might pay to combine it with their own business, since the workers can't get that value out of it.
@@ -104,7 +134,7 @@ So buyouts get:
 - **Their own money.** $100 million, set aside in the same one-time charter, separate from the $350 million for new co-ops. That raises taxpayers' worst case from $350 million to $450 million, and the model says so. $12 million of it pays for the workers' advisers, the checks on deals that don't close and the help after a sale ([What the help costs](#what-the-help-costs)). Buyout loans can never draw on the startup money or the startup help budget, so they can't shrink the main test.
 - **Their own limits.** The same $3 million lifetime limit, which covers every business owned by the same seller or group, so one owner can't split a company into pieces to get around it. The same caps on industries and places apply. With a private lender's share and the seller's share on top, that means companies priced up to about $5 million: small and mid-sized firms. Bigger sales can use the ESOP market that already exists.
 - **Their own test, judged at year 12 with the rest.** It has two parts, and both must pass:
-  1. **The money.** The buyout money has to earn at least the Treasury rate after all losses and costs, including the advisers' budget, the appraisals and the track's share of running the bank. Its losses can't be clearly higher than the loss rate the bank publishes before its first buyout loan ([below](#who-buyouts-are-compared-against)). Deals the bank made alone count, and so do loans restructured to keep them alive, under the same rules as the startup test ([Keeping zombies alive](pilot-safeguards.md#keeping-zombies-alive)).
+  1. **The money.** The buyout money has to earn at least the Treasury rate after all losses and costs, including the advisers' budget, the appraisals, the track's share of running the bank, and the federal tax sellers put off under the [old tax break](#the-tax-break-that-already-exists). Its losses can't be clearly higher than the loss rate the bank publishes before its first buyout loan ([below](#who-buyouts-are-compared-against)). Deals the bank made alone count, and so do loans restructured to keep them alive, under the same rules as the startup test ([Keeping zombies alive](pilot-safeguards.md#keeping-zombies-alive)).
   2. **The pay.** The test follows everyone who was on the payroll at the sale, members or not, whether their firm is still open or not. Their median pay per hour, after inflation, can't have fallen below what it was over the last two audited years before the sale. Workers whose firm closed count at what linked government wage records show they earn now, and as below the line where no record can be found. A track that gets repaid by cutting pay, or by letting the lowest-paid go, hasn't passed.
 
   The two tracks pass or fail on their own. A good buyout record can't rescue a failing startup test, and a bad one can't sink a passing one.
@@ -194,16 +224,17 @@ Three groups of businesses can be followed. None of them makes a clean experimen
 
 **Pay and jobs.** Neither public record has pay. The track's pay test uses the co-ops' own payroll and linked government wage records ([The Pilot](pilot-spec.md#what-gets-measured)). The bank applies for access to those records before the first buyout loan. If access is refused, the report says so instead of leaving the comparison out quietly. Pay growth is also compared with pay in the same industry and county from public wage statistics.
 
-**Where the money went.** For each deal, and for the track as a whole, the report adds up 12 years of payments: to the seller, including everything counted as part of the price, interest to the private lender and to the bank, and what members got above their pay before the sale, in wages, profit shares and account balances. Passing the pay test only shows that workers weren't made worse off while they paid for the business. The ledger shows how much they gained, and how much went to the seller and the lenders.
+**Where the money went.** For each deal, and for the track as a whole, the report adds up 12 years of payments: to the seller, including everything counted as part of the price, interest to the private lender and to the bank, and what members got above their pay before the sale, in wages, profit shares and account balances. Passing the pay test only shows that workers weren't made worse off while they paid for the business. The ledger shows how much they gained, and how much went to the seller and the lenders. The seller's line includes any capital gains tax they put off ([above](#the-tax-break-that-already-exists)).
 
 **What none of this covers.** Most small businesses change hands with no SBA loan and no ESOP, through cash, private loans and seller financing, and those sales leave no public trail. So the comparisons show how buyouts do against two kinds of financed sale and against deals that fell through, not against every sale.
 
-**Expect opposition.** Business brokers and private equity funds, who make money when owners sell, may see a public lender as a competitor. Italy's main employers' association got part of its worker-buyout program suspended by the EU ([Has This Been Tried?](precedents.md#italys-co-op-funds-coopfond-and-the-marcora-law)). Keeping the bank at market rates with no tax break is the best defense, because it leaves little to call unfair. The rest is in [Making It Last](durability.md).
+**Expect opposition.** Business brokers and private equity funds, who make money when owners sell, may see a public lender as a competitor. Italy's main employers' association got part of its worker-buyout program suspended by the EU ([Has This Been Tried?](precedents.md#italys-co-op-funds-coopfond-and-the-marcora-law)). Keeping the bank at market rates with no new tax break is the best defense, because it leaves little to call unfair. Critics can still point to the old break, which is why its cost counts against the track. The rest is in [Making It Last](durability.md).
 
 ## What this doesn't solve
 
 - **The workers pay for what they helped build.** A fair price is a price for the owner's years of ownership, and the workers pay it out of profits their own work will produce. This model accepts that, because the alternative is taking the business, and it doesn't take anyone's business. The rules keep the price fair. They can't make it free.
 - **These loans have less behind them than ordinary ones.** Almost no cash from the buyers, no personal guarantees and a seller who waits two years, not ten. The coverage test and the seller's paid-last share carry the weight that cash and guarantees carry in an SBA loan. The cushion is also thinner than in past co-op buyouts: the main loan here is about 80% of the price, where the conversions Project Equity reviewed had 50–70% in main loans, with other lenders as well as the seller paid after them. If that isn't enough, it will show up as losses above the published rate, and the track fails its test.
+- **An old tax break rides along.** Sellers who qualify can put off, and often never pay, capital gains tax. The model counts its cost against the track but doesn't stop it. If many sellers take it, the track will probably fail its money test.
 - **The seller always knows more.** Written disclosures, checked profits and a shrinking seller's share make hiding problems costly. They can't make it impossible.
 - **A fair price is a matter of judgment.** Appraisals are estimates. The rules make overpaying harder and put the seller's own money behind the price, but they can't make valuation exact.
 - **The vote can be pressured.** A secret ballot, a neutral ballot and a majority of everyone eligible help. They can't stop a well-liked owner or manager from leaning on people in the break room.

JoshHeaps.Net/Content/Socialism/open-problems.md

@@ -35,7 +35,7 @@ An honest list of what the model hasn't solved yet, most dangerous first.
 
 11. **Federal or state?** *(Mostly answered.)* The test stays federal, because one bank with one plan makes one clean experiment. Any state can copy the bank under the same published rules, reported separately, and a model state law protects the lock for co-ops that choose it ([The Lock in State Law](lock-state-law.md); [Making It Last](durability.md#federal-test-state-copies)). No state has adopted anything like it, and a co-op organized in a state that hasn't relies on its charter alone. Still open: whether a few state lenders sharing one plan would have been the stronger experiment after all, since the most durable public bank in America, North Dakota's, is a state bank.
 
-12. **Voluntary buyouts: in or out?** *(Answered.)* In, on a separate track: $100 million of its own, healthy firms only, a willing seller, no new tax break, a capped price the seller shares the risk on, a vote of the whole workforce, and its own test of money and pay, so it can't flatter the startup result ([When an Owner Wants to Sell to the Workers](buyouts.md)). Still open: whether a price set by the market is fair to workers who pay it out of their own future work, and whether about 60 deals can show more than that the loans get repaid. The comparisons are now set out: SBA-financed purchases, ESOP sales and deals that fell through, with a loss rate fixed by formula in advance ([Who buyouts are compared against](buyouts.md#who-buyouts-are-compared-against)). With so few deals, the loss test can catch a track that does much worse than SBA lending, but it can't show that buyouts do better. Why co-ops can't simply use the SBA is now spelled out: its rules ask a co-op, unlike an ESOP, for cash up front and one member's personal guarantee. The bank's deals do without both, so they rest on the seller's paid-last share and a coverage test on past cash flow ([Why not just use the SBA?](buyouts.md#why-not-just-use-the-sba)). Under the SBA's rules from October 2026, those two rules are nearly the whole gap, and both are SBA policy it could change itself. If it does, or a small fund covers the cash stake, much of the track may not be needed. Whether that's enough in place of cash and guarantees is something only the loss record will show. State programs paid for by Treasury and USDA's rural guarantees already allow co-op buyouts in pieces. The track uses them, but can't count them as private money or use them to hide losses ([Other public help](buyouts.md#other-public-help-that-already-exists)). How often private lenders will really take an equal share is unknown, so deals the bank makes alone are capped at a third of the money. The help each sale needs, the workers' adviser, checks on deals that fall through and help after the sale, costs the public roughly $110,000 to $240,000 per closed deal, about $12 million in all. That comes out of the same margin the money test measures, so the track passes only if losses stay low ([What the help costs](buyouts.md#what-the-help-costs)).
+12. **Voluntary buyouts: in or out?** *(Answered.)* In, on a separate track: $100 million of its own, healthy firms only, a willing seller, no new tax break, a capped price the seller shares the risk on, a vote of the whole workforce, and its own test of money and pay, which counts the tax sellers put off under an old tax break ([The tax break that already exists](buyouts.md#the-tax-break-that-already-exists)), so it can't flatter the startup result ([When an Owner Wants to Sell to the Workers](buyouts.md)). Still open: whether a price set by the market is fair to workers who pay it out of their own future work, and whether about 60 deals can show more than that the loans get repaid. The comparisons are now set out: SBA-financed purchases, ESOP sales and deals that fell through, with a loss rate fixed by formula in advance ([Who buyouts are compared against](buyouts.md#who-buyouts-are-compared-against)). With so few deals, the loss test can catch a track that does much worse than SBA lending, but it can't show that buyouts do better. Why co-ops can't simply use the SBA is now spelled out: its rules ask a co-op, unlike an ESOP, for cash up front and one member's personal guarantee. The bank's deals do without both, so they rest on the seller's paid-last share and a coverage test on past cash flow ([Why not just use the SBA?](buyouts.md#why-not-just-use-the-sba)). Under the SBA's rules from October 2026, those two rules are nearly the whole gap, and both are SBA policy it could change itself. If it does, or a small fund covers the cash stake, much of the track may not be needed. Whether that's enough in place of cash and guarantees is something only the loss record will show. State programs paid for by Treasury and USDA's rural guarantees already allow co-op buyouts in pieces. The track uses them, but can't count them as private money or use them to hide losses ([Other public help](buyouts.md#other-public-help-that-already-exists)). How often private lenders will really take an equal share is unknown, so deals the bank makes alone are capped at a third of the money. The help each sale needs, the workers' adviser, checks on deals that fall through and help after the sale, costs the public roughly $110,000 to $240,000 per closed deal, about $12 million in all. That comes out of the same margin the money test measures, so the track passes only if losses stay low ([What the help costs](buyouts.md#what-the-help-costs)).
 
 13. **Work where people don't stay long.** *(Partly answered.)* In home care, most workers leave within a year or two. Membership is now automatic after a short probation, the buy-in comes out of profit shares rather than pay, and pushing people out before they'd join counts against the co-op ([When People Don't Stay Long](high-turnover.md)). Still open: with a five-to-ten-year profit share ramp, only a small minority of care workers ever reach a full share, so the people who stay collect much of the profit the others helped make. A much shorter ramp for low-margin, high-turnover co-ops would fix that, but it would go against the founding plan's range and weaken the ramp's protection against under-hiring. Also open: whether default members take part in governance, and whether Social Security counts a profit share as earned income for SSI, which decides whether members on SSI lose more by joining. SSI may also count an account credit as income when it's made. Until Social Security answers, members on SSI get their share all in cash and join only if they say yes ([How a Locked Co-op Is Taxed](taxes.md#benefits)), and workers who have only an IRS taxpayer number still can't be members. How labor law treats worker-owners now has its own page ([Owners Are Still Workers](labor-law.md)). Federal labor law probably doesn't protect members' own organizing, so the charter does, and fixing the law takes a separate bill that may never pass. Some states leave members out of unemployment insurance, and whether founders' unpaid work before the co-op forms is outside wage law still needs the Labor Department's answer. A federal rule due in 2030 requires 80% of certain Medicaid home care payments to go to care workers' pay. Co-ops meet it from wages alone and pay any shortfall as wages, but in that work it leaves little room for profit shares or a reserve, and whether the rule survives is unknown ([When Medicaid decides how much goes to pay](high-turnover.md#when-medicaid-decides-how-much-goes-to-pay)).