Employee Stock Ownership Plans (ESOP) are qualified retirement programs available to corporations with tax advantages to both the employees, the company and the owner/former owner.
ESOPs are formed with the creation of an ESOP trust which buys the stock, in part or in whole, from a shareholder or shareholders of the corporation. The selling shareholder of a C corporation may be able to defer any capital gains on the sale under Section 1042 of the Internal Revenue Code provided the proceeds are reinvested in stocks, bonds or other securities.
In addition to the deferral of tax on sale, annual contributions to the ESOP are tax deductible to the company. ESOPs do not pay income taxes on their share of profits and employees do not pay income taxes on their allocated value of the stock until withdrawal at retirement.
The tax advantages are not the only reasons to consider forming an ESOP. An ESOP is a useful planning tool for owners ready to transition to retirement. The ESOP rewards the employees who have helped build the successful company. The owner can remain as a key person in management or on the board of directors while transitioning existing management to eventually run the company. In the meantime, the management is more invested in seeing the company succeed as the success of the company will have a direct benefit on their retirement account balances.
It’s not just management that often feels more loyal to the company. Employees who are now “owners” of the company feel more loyal and productive. An ESOP can be a recruiting tool for small businesses who may not be able to offer the same compensation or benefits as a larger corporation.
Many small business owners are hesitant to sell to private equity or a larger corporation as they are uncertain how much of their core business will remain. With an ESOP, the company remains to preserve the legacy of the original founders.
ESOPs are not right for every company. Forming and maintaining an ESOP can be costly. If profit levels are low, an ESOP probably is not right. Companies with high employee turnover may not see the advantages of forming an ESOP, nor would it be appropriate for companies that rely heavily on contract workers. The seller will also likely yield more from a strategic buyer of the company than from the sale to an ESOP.
If you are looking at retirement and not sure what you will do with your company, learn some more about ESOPs. You might really like them.
Melissa E. Loughlin-Sines. CPA, CFE, CVA, CFF, ABV