ESOP Tax Advantages: Our #1 Strategy

An employee stock ownership plan is another way companies can reward employees. Rather than cash contributions to a 401(k), some employers offer an ESOP or the money the employer contributes to its employees invests directly back into the company stock.

This makes employees owners of the company, but it also provides employees with many tax advantages.

How are ESOPs Used?

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ESOPs have many uses for businesses including:

  • Buy out an owner – If one owner wants to leave the business, the ESOP can buy out the owner. The remaining owner can make cash contributions to the ESOP and use it to buy the other owner’s part of the business.
  • Borrow money – If the ESOP borrows money to buy shares, the company makes contributions to pay back the loan which are then tax deductible.
  • Reward employees – An ESOP is another way to reward employees besides paying them in cash or contributing to their retirement funds

When used as an employee reward, ESOPs are great motivation to get employees to keep the company operating at its best. When employees have ‘skin in the game’ because they are part owners, they are more likely to work harder.

Tax Advantages of ESOPs

Contribution and Dividend Deductions

Employers must contribute to their ESOP. They can do so with cash or other assets, such as stocks.

Employers can issue new shares, taking the tax deduction or contribute cash and also take the deduction. The cash can either be to create new shares or create a cash reserve in the ESOP and be tax deductible.

Money used to Repay an ESOP Loan are Deductible

If the ESOP takes out a loan to buy more shares, and the employer contributes cash to pay it off, the employer can deduct the contributions as if they were cash contributions.

S Corporations can Avoid Federal Tax on ESOP Ownership

Any portion of the company’s ownership held in an ESOP isn’t taxed federally and in most cases the state level too. This could mean the S corp pays little to no taxes on the portion of the company owned by the ESOP. If the S corp is 100% owned by the ESOP, there’s no income tax. If they are only partially owned by the ESOP, only that portion isn’t taxable.

Dividends can be Tax Deductible

Dividends used to pay an ESOP can be deducted as long as they are paid to employees and/or employees reinvested the funds in the ESOP.

Final Thoughts

The ESOP tax advantages are a great way to make the most of your company’s funds. You’ll reward your employees, give your business tax advantages, and have more funding for your business.

With employees as owners, there’s often more desire or motivation to work hard and keep the company afloat. Everyone wins with an ESOP as it’s a great way to make the most of a company’s hard-earned money and abilities to flourish in the future.

Paul Sundin

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