Sometimes, rather than focus on tax planning with an ESOP/S CORP for a start up to minimize income taxes (assuming profits), it makes more sense to operate as a taxable C corporation for 5 years or more, pay tax on the corporate income, and then sell the corporation to take advantage of the 100% §1202 qualified small business stock exclusion.
For example, assume optimistically your start up earns $1,000,000 for 5 years and pays a 30% combined federal and state tax (in California) thereon for 5 years. That's $1,500,000 in tax. But then assume you sell your start up corporation for 25 times earnings. That's $25,000,000, but it's all tax-free under §1202. On these optimistic hypothetical facts, your overall tax cost is $1,500,000, but that's a tax burden of only 6%, a pretty good result, and similar to a real estate broker's commission. Of course, more realistically, if your start up had losses or modest income in those first few years, the tax burden would be much less than the 6% in the example.
