Reasons to consider an Employer Stock Ownership Plan
Succession planning is always a challenge for the private business owner. Finding a buyer for business is not only difficult but also time consuming. Some owners do not want to transition their business to their current employees but they may not have the financial means to consummate a sale.
The consideration of creating an Employee Stock Ownership Plan (ESOP) may be the solution. Some of the benefits are:
Tax Benefits
- Employees participating in an ESOP are not taxed on stock allocated to their accounts until they receive distributions, which is usually when they retire or leave the company.
- The employer can under certain circumstances deduct contributions to the ESOP, including both interest and principal on loans the ESOP uses to buy the company stock. The company can also donate their shares of stock to the ESOP and get a deduction.
- C Corporations can get a deduction for dividends paid to an ESOP used to repay loans, passed through to the participants or reinvested in company stock.
- The owner of the C Corporation can defer taxation of the sale of the stock to the ESOP by complying with Internal Revenue Code Section 142 requirements.
- S Corporations ESOPs do not pay taxes on their portion of the corporation’s income. The distributions paid to the ESOP can be used to pay down loans, fund benefits, or pay for administration expenses.
Benefits to the Employees who participate
- Once an ESOP is established employees have an additional benefit that is not taxed until they receive distributions, which can then roll over into an Individual Retirement Account (IRA).
- ESOP shares allow employees to have an invested interest in the financial well-being of the company on the same level as the original owners.
- ESOPs can be a valuable asset to employees retirement planning.
- ESOP contributions can be used to match employee 401(k) contributions, even under safe harbor matching formula. This creates greater participation in the company’s 401(k) plan making antidiscrimination testing requirements easier to comply with.
Benefits to the Employers
- ESOPs can borrow money on employer credit to acquire the company stock. This alleviates cash funding challenges for the employees if they were to buy the company on their own.
- Borrowed funds can be used to repurchase shares with pre-tax dollars.
- Borrowed funds can be used to purchase new capital equipment needs, refinance other debt, to purchase other companies and other business purposes.
- Employers benefit from ESOPs in the increase in morale and productivity of the ESOP owned employees. Employees are more productive when they have a vested interest in the financial welfare of the business.
Employee Stock Ownership Plans (ESOPs) present a strategic and tax-efficient solution for private business owners navigating the challenges of succession planning. With benefits spanning tax advantages for both employees and employers, enhanced retirement planning, and a positive impact on company dynamics, ESOPs emerge as a compelling strategy. By fostering a sense of ownership and aligning the interests of owners and employees, ESOPs offer a symbiotic approach to succession, ensuring a smoother transition for businesses and their stakeholders