ESOP Tax Advantages: Top 3 Benefits & Strategies


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An employee stock ownership plan (ESOP) can be a significant tax and estate planning structure. It allows a business owner to retain and motivate certain employees that have made significant contributions to the business. In addition, it provides an excellent exit strategy for owners.

This post will talk about all the benefits of ESOPs and dive into some specific questions. So let’s get started.

What is an ESOP?

An ESOP is technically a type of retirement structure. It allows employees to benefit from ownership in the company. The company stock is actually held in trust for the benefit of the employee participants. However, the trust is technically the legal stock owner.

Once the stock is in the trust, it is allocated to the employees specifically. Over time, the shares given to the participants will generally increase the value of the stock as well in most situations. When the participant leaves the company, they can sell the stock back to the business.

There are two distinct types of ESOPs:

  • Leveraged. This type of Aesop will borrow money to buy stock from the selling shareholders. That stock will then be allocated to employees over time as the loan is paid down. This is the most common form of Aesop.
  • Non-leveraged. For this type of ESOP, the company will contribute cash to the plan, and the ESOP will then buy the stock shares. Alternatively, the company can contribute shares directly to the ESOP.

How does an ESOP work as an owner exit strategy?

ESOPs can be a great exit strategy for business owners. Like any structure, some advantages and disadvantages need to be considered.

Bottom line, a selling business owner should consider many different options when examining if an ESOP is something they want to consider. The plans can be used in various companies and industries but are often used in professional services, construction, manufacturing, and distribution.

Taxes written on hanging tags

One of the considerable benefits to ESOPs is that many owners have a significant share of their personal wealth in shares of the company. As these older owners get older and look to diversify and examine estate tax implications, an option of selling a portion of the business to an ESOP can become appealing. It creates a liquidity event and is also an effective estate planning tool.

An ESOP can allow retirement proceeds to be allocated to substantially more employees than what they could get in a traditional retirement structure like a 401(k), cash balance plan, or defined benefit plan.

ESOPs also can provide a variety of other options considering the following:

  • Selling or transferring the company to senior management or key employees.
  • Transferring ownership to another generation
  • Selling to a private equity firm or in a buyout.
  • Disposing of shares to a large strategic fire.

ESOP Tax Advantages

Let’s first look at some of the tax benefits. The Congress and IRS have given business owners a lot of incentives and motivation for shareholders to use ESOPs to allocate ownership to employees. As a result, there are many tax benefits for business owners.

Here are the top three tax benefits allowed by ESOPs:

  • Tax deferral. When an owner sells stock to the ESOP, it can be structured as tax deferred. However, this is only available for owners of C corporations.
  • Federal income tax. A 100% ESOP owned S Corp. will pay no federal income tax. This makes it simple for the company to service any outstanding debt and reduces risk in a leveraged transaction compared to a traditional leveraged buyout structure.
  • Text advantaged leveraged buyout structure. Congress allows the company to deduct the principal paid on the loan incurred for the ESOP to buy the stock in the ESOP. This is one huge advantage and little-known.

Paul Sundin

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