What’s the Magic about an ESOP?

Employee Stock Ownership Plans (ESOPs) are not magic but they are probably one of the most misunderstood employee benefit plans in existence today. It’s true they are a tax-qualified retirement plan like a profit-sharing or 401-k plan with two important distinctions:

• They are required to invest primarily in the stock of the sponsoring employer. Other plans are required to diversify their asset holdings.
• It’s the only employee benefit plan that may use corporate credit to finance the purchase of company stock from a shareholder. For other plans, this would be a prohibited transaction.

But ESOPs are much more than a retirement plan. A privately held business owner can sell some or all of his or her business at fair market value to a ready and willing buyer (the ESOP) and elect to pay no tax on the sale. Or, they can sell a significant portion of their stock to diversify their personal net worth and still maintain control of their companies. An ESOP can borrow money to finance the transaction and pay down the debt with tax deductible contributions to the ESOP creating a deduction for both the principal payment and the interest. This unique leveraging ability allows business owners to use their ESOP to grow their companies by making tax advantaged acquisitions. Why does the government allow these potent tax advantages to ESOP sponsors? Because ESOPs are a marvelous tool to help companies become more profitable and enable employees to “share in the wealth.” And wealth distribution is a major contributing factor to the long-term health of a free and democratic society. Academic and commercial research studies show that ESOPs motivate employees to higher levels of productivity and profitability.

With all of these advantages, what’s the catch? The evaluation and implementation of an ESOP is complex requiring multiple levels of tax, legal, actuarial, financial and administrative expertise. That’s where we can help.