Title 26 — Internal Revenue CodeRelease 119-73
§1042 Sales of stock to employee stock ownership plans or certain cooperatives
Title 26 › Subtitle Subtitle A— - Income Taxes › Chapter CHAPTER 1— - NORMAL TAXES AND SURTAXES › Subchapter Subchapter O— - Gain or Loss on Disposition of Property › Part PART III— - COMMON NONTAXABLE EXCHANGES › § 1042
Summary
Lets a seller delay paying tax on gain when they sell certain private company stock to an employee stock ownership plan (ESOP) or an eligible worker-owned cooperative, if the seller chooses the tax break, the buyer owns enough stock right after the sale, the seller held the stock at least 3 years, and the seller buys qualifying replacement stock within a set time. The buyer must own at least 30% of the company’s stock (by class or by value) right after the sale. The seller must file a written statement from the employer or an officer of the cooperative and make the election by the due date (including extensions) of their tax return. Sales by underwriters in the normal course of business don’t count. The tax break does not apply to gain that is included in the income of any C corporation. Qualified securities: employer stock of a private C corporation that is not readily tradable and was not received from certain plans or option rules. Eligible worker-owned cooperative: a cooperative covered by subchapter T whose members are mainly employees, who own most voting stock, elect most directors one-person-one-vote, and get most earnings/losses by patronage or capital. Replacement period: starts 3 months before the sale and ends 12 months after. Qualified replacement property: securities of a domestic operating corporation that did not have passive investment income over 25% of receipts in the prior year and that is not the same or a related company. The basis of the new stock is reduced by the amount of gain deferred, and if the seller later sells the replacement stock (or in some big asset sales by that issuer), the deferred gain becomes taxable. There are special rules for sales to eligible farmers’ cooperatives (they must end up with 100% ownership for the rule to apply) and for refiners/processors who buy most products from the member farmers.
Full Legal Text
Title 26, §1042
Internal Revenue Code — Source: USLM XML via OLRC
(a)If—
(1)the taxpayer or executor elects in such form as the Secretary may prescribe the application of this section with respect to any sale of qualified securities,
(2)the taxpayer purchases qualified replacement property within the replacement period, and
(3)the requirements of subsection (b) are met with respect to such sale,
(b)A sale of qualified securities meets the requirements of this subsection if—
(1)The qualified securities are sold to—
(A)an employee stock ownership plan (as defined in section 4975(e)(7)), or
(B)an eligible worker-owned cooperative.
(2)The plan or cooperative referred to in paragraph (1) owns (after application of section 318(a)(4)), immediately after the sale, at least 30 percent of—
(A)each class of outstanding stock of the corporation (other than stock described in section 1504(a)(4)) which issued the qualified securities, or
(B)the total value of all outstanding stock of the corporation (other than stock described in section 1504(a)(4)).
(3)(A)The taxpayer files with the Secretary the written statement described in subparagraph (B).
(B)A statement is described in this subparagraph if it is a verified written statement of—
(i)the employer whose employees are covered by the plan described in paragraph (1), or
(ii)any authorized officer of the cooperative described in paragraph (l),11 So in original. Probably should be “paragraph (1),”.
(4)The taxpayer’s holding period with respect to the qualified securities is at least 3 years (determined as of the time of the sale).
(c)For purposes of this section—
(1)The term “qualified securities” means employer securities (as defined in section 409(l)) which—
(A)are issued by a domestic C corporation that has no stock outstanding that is readily tradable on an established securities market, and
(B)were not received by the taxpayer in—
(i)a distribution from a plan described in section 401(a), or
(ii)a transfer pursuant to an option or other right to acquire stock to which section 83, 422, or 423 applied (or to which section 422 or 424 (as in effect on the day before the date of the enactment of the Revenue Reconciliation Act of 1990) applied).
(2)The term “eligible worker-owned cooperative” means any organization—
(A)to which part I of subchapter T applies,
(B)a majority of the membership of which is composed of employees of such organization,
(C)a majority of the voting stock of which is owned by members,
(D)a majority of the board of directors of which is elected by the members on the basis of 1 person 1 vote, and
(E)a majority of the allocated earnings and losses of which are allocated to members on the basis of—
(i)patronage,
(ii)capital contributions, or
(iii)some combination of clauses (i) and (ii).
(3)The term “replacement period” means the period which begins 3 months before the date on which the sale of qualified securities occurs and which ends 12 months after the date of such sale.
(4)(A)The term “qualified replacement property” means any security issued by a domestic operating corporation which—
(i)did not, for the taxable year preceding the taxable year in which such security was purchased, have passive investment income (as defined in section 1362(d)(3)(C)) in excess of 25 percent of the gross receipts of such corporation for such preceding taxable year, and
(ii)is not the corporation which issued the qualified securities which such security is replacing or a member of the same controlled group of corporations (within the meaning of section 1563(a)(1)) as such corporation.
(B)For purposes of this paragraph—
(i)The term “operating corporation” means a corporation more than 50 percent of the assets of which were, at the time the security was purchased or before the close of the replacement period, used in the active conduct of the trade or business.
(ii)The term “operating corporation” shall include—
(I)any financial institution described in section 581, and
(II)an insurance company subject to tax under subchapter L.
(C)(i)For purposes of applying this paragraph, if—
(I)the corporation issuing the security owns stock representing control of 1 or more other corporations,
(II)1 or more other corporations own stock representing control of the corporation issuing the security, or
(III)both,
(ii)For purposes of clause (i), the term “control” has the meaning given such term by section 304(c). In determining control, there shall be disregarded any qualified replacement property of the taxpayer with respect to the section 1042 sale being tested.
(D)For purposes of this paragraph, the term “security” has the meaning given such term by section 165(g)(2), except that such term shall not include any security issued by a government or political subdivision thereof.
(5)No sale of securities by an underwriter to an employee stock ownership plan or eligible worker-owned cooperative in the ordinary course of his trade or business as an underwriter, whether or not guaranteed, shall be treated as a sale for purposes of subsection (a).
(6)An election under subsection (a) shall be filed not later than the last day prescribed by law (including extensions thereof) for filing the return of tax imposed by this chapter for the taxable year in which the sale occurs.
(7)Subsection (a) shall not apply to any gain on the sale of any qualified securities which is includible in the gross income of any C corporation.
(d)The basis of the taxpayer in qualified replacement property purchased by the taxpayer during the replacement period shall be reduced by the amount of gain not recognized by reason of such purchase and the application of subsection (a). If more than one item of qualified replacement property is purchased, the basis of each of such items shall be reduced by an amount determined by multiplying the total gain not recognized by reason of such purchase and the application of subsection (a) by a fraction—
(1)the numerator of which is the cost of such item of property, and
(2)the denominator of which is the total cost of all such items of property.
(e)(1)If a taxpayer disposes of any qualified replacement property, then, notwithstanding any other provision of this title, gain (if any) shall be recognized to the extent of the gain which was not recognized under subsection (a) by reason of the acquisition by such taxpayer of such qualified replacement property.
(2)If—
(A)a corporation issuing qualified replacement property disposes of a substantial portion of its assets other than in the ordinary course of its trade or business, and
(B)any taxpayer owning stock representing control (within the meaning of section 304(c)) of such corporation at the time of such disposition holds any qualified replacement property of such corporation at such time,
(3)Paragraph (1) shall not apply to any transfer of qualified replacement property—
(A)in any reorganization (within the meaning of section 368) unless the person making the election under subsection (a)(1) owns stock representing control in the acquiring or acquired corporation and such property is substituted basis property in the hands of the transferee,
(B)by reason of the death of the person making such election,
(C)by gift, or
(D)in any transaction to which section 1042(a) applies.
(f)If any gain is realized by the taxpayer on the sale or exchange of any qualified securities and there is in effect an election under subsection (a) with respect to such gain, then—
(1)the statutory period for the assessment of any deficiency with respect to such gain shall not expire before the expiration of 3 years from the date the Secretary is notified by the taxpayer (in such manner as the Secretary may by regulations prescribe) of—
(A)the taxpayer’s cost of purchasing qualified replacement property which the taxpayer claims results in nonrecognition of any part of such gain,
(B)the taxpayer’s intention not to purchase qualified replacement property within the replacement period, or
(C)a failure to make such purchase within the replacement period, and
(2)such deficiency may be assessed before the expiration of such 3-year period notwithstanding the provisions of any other law or rule of law which would otherwise prevent such assessment.
(g)(1)This section shall apply to the sale of stock of a qualified refiner or processor to an eligible farmers’ cooperative.
(2)For purposes of this subsection, the term “qualified refiner or processor” means a domestic corporation—
(A)substantially all of the activities of which consist of the active conduct of the trade or business of refining or processing agricultural or horticultural products, and
(B)which, during the 1-year period ending on the date of the sale, purchases more than one-half of such products to be refined or processed from—
(i)farmers who make up the eligible farmers’ cooperative which is purchasing stock in the corporation in a transaction to which this subsection is to apply, or
(ii)such cooperative.
(3)For purposes of this section, the term “eligible farmers’ cooperative” means an organization to which part I of subchapter T applies and which is engaged in the marketing of agricultural or horticultural products.
(4)In applying this section to a sale to which paragraph (1) applies—
(A)the eligible farmers’ cooperative shall be treated in the same manner as a cooperative described in subsection (b)(1)(B),
(B)subsection (b)(2) shall be applied by substituting “100 percent” for “30 percent” each place it appears,
(C)the determination as to whether any stock in the domestic corporation is a qualified security shall be made without regard to whether the stock is an employer security or to subsection (c)(1)(A), and
(D)paragraphs (2)(D) and (7) of subsection (c) shall not apply.
Legislative History
Notes & Related Subsidiaries
Amendment of Section Pub. L. 117–328, div. T, title I, § 114, Dec. 29, 2022, 136 Stat. 5296, provided that, applicable to sales after Dec. 31, 2027, this section is amended: (a) in subsection (c)(1)(A), by striking “domestic C corporation” and inserting “domestic corporation”; and (b) by adding at the end the following new subsection: (h) Application of section to sale of stock in S corporation In the case of the sale of qualified securities of an S corporation, the election under subsection (a) may be made with respect to not more than 10 percent of the amount realized on such sale for purposes of determining the amount of gain not recognized and the extent to which (if at all) the amount realized on such sale exceeds the cost of qualified replacement property. The portion of adjusted basis that is properly allocable to the portion of the amount realized with respect to which the election is made under this subsection shall be taken into account for purposes of the preceding sentence. See 2022 Amendment notes below.
Editorial Notes
References in Text
The date of the enactment of the Revenue Reconciliation Act of 1990, referred to in subsec. (c)(1)(B)(ii), is the date of enactment of Pub. L. 101–508, which was approved Nov. 5, 1990. The Tax Reform Act of 1986, referred to in subsec. (c)(4)(A), is Pub. L. 99–514, which was approved Oct. 22, 1986.
Amendments
2022—Subsec. (c)(1)(A). Pub. L. 117–328, § 114(a), substituted “domestic corporation” for “domestic C corporation”. Subsec. (h). Pub. L. 117–328, § 114(b), added subsec. (h). 1997—Subsec. (g). Pub. L. 105–34 added subsec. (g). 1996—Subsec. (c)(1)(A). Pub. L. 104–188, § 1316(d)(3), substituted “domestic C corporation” for “domestic corporation”. Subsec. (c)(1)(B)(ii). Pub. L. 104–188, § 1704(t)(50), provided that section 11801(c)(9)(H) of Pub. L. 101–508 shall be applied as if “section 1042(c)(1)(B)” appeared instead of “section 1042(c)(2)(B)”. See 1990 Amendment note below. Subsec. (c)(4)(A)(i). Pub. L. 104–188, § 1311(b)(3), substituted “section 1362(d)(3)(C)” for “section 1362(d)(3)(D)”. Subsec. (c)(4)(B)(ii)(I). Pub. L. 104–188, § 1616(b)(13), struck out “or 593” after “section 581”. 1990—Subsec. (c)(1)(B)(ii). Pub. L. 101–508, which directed the amendment of subsec. (c)(2)(B)(ii) by substituting “section 83, 422, or 423 applied (or to which section 422 or 424 (as in effect on the day before the date of the enactment of the Revenue Reconciliation Act of 1990) applied)” for “section 83, 422, 422A, 423, or 424 applies”, was executed to subsec. (c)(1)(B)(ii). See 1996 Amendment note above. 1989—Subsec. (b)(4). Pub. L. 101–239 added par. (4). 1988—Subsec. (b)(3), (4). Pub. L. 100–647, § 1018(t)(4)(F), made technical correction to Pub. L. 99–514, § 1854(a)(3)(B), see 1986 Amendment notes below. Subsec. (c)(4)(A). Pub. L. 100–647, § 1018(t)(4)(D), inserted “(as in effect immediately before the Tax Reform Act of 1986)” after “section 954(c)(3)” in last sentence. Subsec. (c)(4)(B)(i). Pub. L. 100–647, § 1018(t)(4)(E), substituted “replacement period” for “placement period”. 1986—Pub. L. 99–514, § 1854(a)(11), which directed that “employee” be inserted before “stock” in section catchline was executed by making the insertion before “stock” the second time that term appears as the probable intent of Congress. Subsec. (a). Pub. L. 99–514, § 1854(a)(1), substituted “the taxpayer or executor elects in such form as the Secretary may prescribe” for “the taxpayer elects” in par. (1) and inserted “which would be recognized as long-term capital gain” in concluding provisions. Subsec. (b)(2). Pub. L. 99–514, § 1854(a)(2)(A), substituted “Plan must hold” for “Employees must own” in heading and amended text generally. Prior to amendment, par. (2) read as follows: “The plan or cooperative referred to in paragraph (1) owns, immediately after the sale, at least 30 percent of the total value of the employer securities (within the meaning of section 409(l)) outstanding as of such time.” Subsec. (b)(3). Pub. L. 99–514, § 1854(a)(3)(B), as amended by Pub. L. 100–647, § 1018(t)(4)(F), redesignated par. (4) as (3) and struck out former par. (3) which related to plans maintained for benefit of employees. Subsec. (b)(3)(B). Pub. L. 99–514, § 1854(f)(3)(B), amended subpar. (B) similar to amendment by section 1854(a)(9)(B) of Pub. L. 99–514, inserting reference to section 4979A. Pub. L. 99–514, § 1854(a)(9)(B), substituted “section 4978 and 4979A” for “section 4978(a)”. Subsec. (b)(4). Pub. L. 99–514, § 1854(a)(3)(B), as amended by Pub. L. 100–647, § 1018(t)(4)(F), redesignated par. (4) as (3). Subsec. (c). Pub. L. 99–514, § 1899A(26), substituted “this section—” for “this section.—” in introductory provision. Subsec. (c)(1). Pub. L. 99–514, § 1854(a)(4), substituted “stock outstanding that is” for “securities outstanding that are” in subpar. (A), redesignated subpar. (C) as (B), and struck out former subpar. (B) which read as follows: “at the time of the sale described in subsection (a)(1), have been held by the taxpayer for more than 1 year, and”. Subsec. (c)(4). Pub. L. 99–514, § 1854(a)(5)(A), amended par. (4) generally. Prior to amendment, par. (4) read as follows: “The term ‘qualified replacement property’ means any securities (as defined in section 165(g)(2)) issued by a domestic corporation which does not, for the taxable year in which such stock is issued, have passive investment income (as defined in section 1362(d)(3)(D)) that exceeds 25 percent of the gross receipts of such corporation for such taxable year.” Subsec. (c)(5). Pub. L. 99–514, § 1854(a)(10), substituted “sold” for “acquired” in heading, and in text substituted “sale of securities” for “acquisition of securities” and inserted “to an employee stock ownership plan or eligible worker-owned cooperative”. Subsec. (c)(7). Pub. L. 99–514, § 1854(a)(6)(A), added par. (7). Subsec. (d). Pub. L. 99–514, § 1854(a)(7), inserted last sentence. Subsecs. (e), (f). Pub. L. 99–514, § 1854(a)(8)(A), added subsec. (e) and redesignated former subsec. (e) as (f).
Statutory Notes and Related Subsidiaries
Effective Date
of 2022 Amendment Pub. L. 117–328, div. T, title I, § 114(c), Dec. 29, 2022, 136 Stat. 5296, provided that: “The
Amendments
made by this section [amending this section] shall apply to sales after December 31, 2027.”
Effective Date
of 1997 Amendment Pub. L. 105–34, title IX, § 968(b), Aug. 5, 1997, 111 Stat. 896, provided that: “The amendment made by this section [amending this section] shall apply to sales after December 31, 1997.”
Effective Date
of 1996 AmendmentAmendment by section 1316(d)(3) of Pub. L. 104–188 applicable to taxable years beginning after Dec. 31, 1997, see section 1316(f) of Pub. L. 104–188, set out as a note under section 170 of this title. Amendment by section 1311(b)(3) of Pub. L. 104–188 applicable to taxable years beginning after Dec. 31, 1996, see section 1317(a) of Pub. L. 104–188, set out as a note under section 641 of this title. Amendment by section 1616(b)(13) of Pub. L. 104–188 applicable to taxable years beginning after Dec. 31, 1995, see section 1616(c) of Pub. L. 104–188, set out as a note under section 593 of this title.
Effective Date
of 1989 Amendment Pub. L. 101–239, title VII, § 7303(b), Dec. 19, 1989, 103 Stat. 2352, provided that: “The amendment made by this section [amending this section] shall apply to sales after July 10, 1989.”
Effective Date
of 1988 AmendmentAmendment by Pub. L. 100–647 effective, except as otherwise provided, as if included in the provision of the Tax Reform Act of 1986, Pub. L. 99–514, to which such amendment relates, see section 1019(a) of Pub. L. 100–647, set out as a note under section 1 of this title.
Effective Date
of 1986 AmendmentAmendment by section 1854(a)(1), (2)(A), (4), (5)(A), (7), (10), (11) of Pub. L. 99–514 effective, except as otherwise provided, as if included in the provisions of the Tax Reform Act of 1984, Pub. L. 98–369, div. A, to which such amendment relates, see section 1881 of Pub. L. 99–514, set out as a note under section 48 of this title. Amendment by section 1854(a)(3)(B) of Pub. L. 99–514 applicable to sales of securities after Oct. 22, 1986, except that a taxpayer or executor may elect to have section 1042(b)(3) of the Internal Revenue Code of 1954 (as in effect before the amendment by section 1854(a)(3)(B) of Pub. L. 99–514) apply to sales before Oct. 22, 1986, as if section 1042(b)(3) included the last sentence of section 409(n)(1) of this title (as added by section 1854(a)(3)(A) of Pub. L. 99–514), see section 1854(a)(3)(C) of Pub. L. 99–514, as amended, set out as a note under section 409 of this title. Pub. L. 99–514, title XVIII, § 1854(a)(6)(B)–(D), Oct. 22, 1986, 100 Stat. 2876, provided that: “(B) The amendment made by subparagraph (A) [amending this section] shall apply to sales after
March 28, 1985, except that such amendment shall not apply to sales made before
July 1, 1985, if made pursuant to a binding contract in effect on
March 28, 1985, and at all times thereafter. “(C) The amendment made by subparagraph (A) shall not apply to any sale occurring on
December 20, 1985, with respect to which—“(i) a commitment letter was issued by a bank on
October 31, 1984, and “(ii) a final purchase agreement was entered into on
November 5, 1985. “(D) In the case of a sale on
September 27, 1985, with respect to which a preliminary commitment letter was issued by a bank on
April 10, 1985, and with respect to which a commitment letter was issued by a bank on
June 28, 1985, the amendment made by subparagraph (A) shall apply but such sale shall be treated as having occurred on
September 27, 1986.” Pub. L. 99–514, title XVIII, § 1854(a)(8)(B), Oct. 22, 1986, 100 Stat. 2877, provided that: “The amendment made by subparagraph (A) [amending this section] shall apply to dispositions after the date of the enactment of this Act [Oct. 22, 1986], in taxable years ending after such date.” Amendment by section 1854(a)(9)(B) of Pub. L. 99–514 applicable to sales of securities after Oct. 22, 1986, see section 1854(a)(9)(D) of Pub. L. 99–514, set out as an
Effective Date
note under section 4979A of this title. Amendment by section 1854(f)(3)(B) of Pub. L. 99–514 effective Oct. 22, 1986, see section 1854(f)(4)(A) of Pub. L. 99–514, set out as a note under section 409 of this title.
Effective Date
Pub. L. 98–369, div. A, title V, § 541(c), July 18, 1984, 98 Stat. 890, provided that: “The
Amendments
made by this section [enacting this section and amending section 1016 and 1223 of this title] shall apply to sales of securities in taxable years beginning after the date of enactment of this Act [July 18, 1984].”
Savings Provision
For provisions that nothing in amendment by Pub. L. 101–508 be construed to affect treatment of certain transactions occurring, property acquired, or items of income, loss, deduction, or credit taken into account prior to Nov. 5, 1990, for purposes of determining liability for tax for periods ending after Nov. 5, 1990, see section 11821(b) of Pub. L. 101–508, set out as a note under section 45K of this title. Plan
Amendments
Not Required Until January 1, 1989For provisions directing that if any
Amendments
made by subtitle A or subtitle C of title XI [§§ 1101–1147 and 1171–1177] or title XVIII [§§ 1800–1899A] of Pub. L. 99–514 require an amendment to any plan, such plan amendment shall not be required to be made before the first plan year beginning on or after Jan. 1, 1989, see section 1140 of Pub. L. 99–514, as amended, set out as a note under section 401 of this title. Ownership of Stock Options as Ownership of Stock; Employee Ownership of Stock After Sale Pub. L. 99–514, title XVIII, § 1854(a)(2)(B), Oct. 22, 1986, 100 Stat. 2873, provided that: “(i) The requirement that section 1042(b) of the Internal Revenue Code of 1954 [now 1986] shall be applied with regard to section 318(a)(4) of such Code shall apply to sales after
May 6, 1986. “(ii) In the case of sales after
July 18, 1984, and before the date of the enactment of this Act [Oct. 22, 1986], paragraph (2) of section 1042(b) of such Code shall apply as if it read as follows:“ ‘(2) Employees must own 30 percent of stock after sale.—The plan or cooperative referred to in paragraph (1) owns, immediately after the sale, at least 30 percent of the employer securities or 30 percent of the value of employer securities (within the meaning of section 409(1)) outstanding at the time of sale.’ ” Replacement Period for Certain Securities Pub. L. 99–514, title XVIII, § 1854(a)(5)(B), Oct. 22, 1986, 100 Stat. 2875, provided that: “If—“(i) before
January 1, 1987, the taxpayer acquired any security (as defined in section 165(g)(2) of the Internal Revenue Code of 1954 [now 1986]) issued by a domestic corporation or by any State or political subdivision thereof, “(ii) the taxpayer treated such security as qualified replacement property for purposes of section 1042 of such Code, and “(iii) such property does not meet the requirements of section 1042(c)(4) of such Code (as amended by subparagraph (A)), then, with respect to so much of any gain which the taxpayer treated as not recognized under section 1042(a) by reason of the acquisition of such property, the replacement period for purposes of such section shall not expire before
January 1, 1987.”
Executive Documents
Line Item Veto Pub. L. 105–34, title IX, § 968, Aug. 5, 1997, 111 Stat. 895, amending this section and enacting provisions set out as a note above, was subject to line item veto by the President, Cancellation No. 97–2, signed Aug. 11, 1997, 62 F.R. 43267, Aug. 12, 1997. For decision holding line item veto unconstitutional, see Clinton v. City of New York, 524 U.S. 417, 118 S.Ct. 2091, 141 L.Ed.2d 393 (1998).
Reference
Citations & Metadata
Citation
26 U.S.C. § 1042
Title 26 — Internal Revenue Code
Last Updated
Apr 6, 2026
Release point: 119-73