The sub-S-Corp gradual purchase structure mentioned by Peter is very effective in accomplishing three objectives:
1. Enabling key employees & managers to purchase the business without outside financing.
2. Transitioning smoothly and seamlessly from one ownership group to another without any loss of momentum.
3. Saving an enormous amount of taxes.
It's very important that the deal be structured carefully with a team of:
a. a business broker familiar with the legal, accounting, tax, and valuation aspects,
b. an accountant who understands complex tax issues, and,
c. an attorney to prepare the essential documents.
A critical factor is how the initial stock purchase is made. Assume that the S-Corp has a total of 1,000 shares issued, all to one owner ("Principal"). The purchaser would buy 1 share and an option to buy 9 shares at some point in the future. As the Principal gradually redeems his shares (20% each year), the proportional ownership of the buyer increases (1/1000 to 1/800 to 1/640 to 1/512, etc.).
Eventually there is enough cash accumulation to redeem all the Principal's remaining shares, except for the 9 shares on which the buyer has an option; so the Principal still owns 90% of the corporation. At this point, the buyer exercises his option and owns 100% of the corporation--10 shares out of the 10 still outstanding. By having the Principal still retaining shares, and particularly, retaining control of the corporation at the end of the redemption activity, the IRS determines that this is not an installment sale and thus the money received for the redemption is tax-free.
Then the the buyer exercises his option to purchase the nine shares and, only then, takes control of the corporation.