About ESOPs

What is an ESOP, and Why Would a Business Owner Consider an ESOP?

Imagine being able to sell all or a portion of your incorporated business in a transaction where you pay no current income tax on the gain you realize on the sale and where the purchase price is a tax-deductible expense for your business! Though it all sounds too good to be true, it is possible to secure exactly this result by selling stock to an Employee Stock Ownership Plan (ESOP).

An ESOP is a qualified defined contribution employee benefit plan under the Internal Revenue Code, with several key differences from other qualified plans:

  • An ESOP is designed and allowed to invest primarily in the stock of the sponsoring corporation
  • An ESOP is allowed to engage in transactions with "parties in interest" such as outside shareholders and corporate officers
  • An ESOP can borrow money, generally to fund stock purchases

These special privileges enable an owner or owners of a corporation to establish an ESOP to either purchase the business on a tax advantaged basis from the current owners, or to fund a liquidity event for the current owners via a purchase of a percentage ownership interest in company stock, while the current owners retain an ownership interest and involvement in the business.

The tax benefits described above are available to C-corporations and their shareholders. If your company is an S-corporation, the tax benefits of selling to an ESOP are different, but just as exciting. It is possible for an S-corporation to effectively "opt out" of the tax system, since the ESOP's share of S-corporation pass through income is not subject to federal income taxes, or to state income taxes in many states.  A 100% ESOP owned S-corporation can effectively be a tax-exempt for-profit business.

For more information on ESOPs, please check out the website of the National Center for Employee Ownership- there are extensive online articles and other material which answer many questions about ESOPs and their tax benefits.

For more in-depth information and to see if an ESOP will work for you and your company, contact us for a free initial consultation.