ESOPs – Benefits Employees & Owners

Employee stock ownership plans benefit the workers and the owners! Unusual tax incentives encourage employers to set up these plans.

ESOPs can work well for large and mid-sized corporations. These plans aren’t for the very small employer with just a few employees. Owners in the lower tax brackets wouldn’t be the best candidates here.

“Stock” is in the name of this type of benefit plan.  You must own a C or S corporation to benefit.

If your company is an S corporation, the end result can even be no income tax.   If the employee benefit plan ends up as the sole owner of the company, the result can be S corporation income flowing only into the exempt-status ESOP.  Imagine competing when your company pays no tax on its profits. 

If the business is a C corporation, the company will still incur tax.   However, the ESOP structure may avoid the owner’s gains tax.  The owner may go from owning privately held stock to owning public stock with a low tax basis.  This may be the end result when the employer is a C corporation and the owner invests in qualified replacement property.   Often, replacement property that defers the gain is in the form of listed stock.

The low tax basis, deferred gain route isn’t available to the shareholder of an S corporation.   On the other hand, a tax-exempt ESOP owning 100% of an S corporation is a uniquely advantaged tax structure.  This approach can effectively eliminate income tax on the business.  

These plans can work particularly well in “exit planning” for the owner.    Are you ready to retire or move on but haven’t found the right buyer for your company?  Such plans can effectively create a buyer for your stock.

The are many design options and decisions in structuring an ESOP.  Yet most transactions will fall into a familiar pattern.  For example, it is not necessary but not uncommon that the ESOP will eventually own all the stock of the company.  

The employer funding such plans gets deductions.   There are percentage limitations on the deductions.  

There are often bank loans to the corporation that end up funding the ESOP’s purchase of the owner’s stock.  

ESOPs may be used to buy out the majority shareholder but they can also be used to buy out significant minority shareholders.  

ESOP planning can sometimes be combined with a sale of significant stock ownership to key employees.  

Design options are varied.    

Are there expenses involved?  Yes.  Plans have to be designed, administered, etc.   A bank is typically involved.  Yet the benefits can also be very significant.   

Financial security for the owner(s) is often a major incentive, as well as creating a stake-in-the-company benefit for workers.  

There are unusual tax incentives encouraging such plans.

The ESOP approach to buying out the owner is an important, tax-advantaged option in the right circumstances.