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Employee Stock Option Plans (ESOPs) Offer Tax and Economic Benefits

Most people think of the United Airlines bankruptcy when they think of ESOPs. That's unfortunate, because ESOPs provide company ownership and employees with both tax and economic advantages. Most importantly, an ESOP does not have to control the company to derive tax benefits.

What are the benefits of an ESOP?

• Your employees share in the company's financial growth.
• A C corporation may generally deduct dividends paid to the ESOP. The sale of your shares to the ESOP may be entitled to deferral of the gain on the sale if you meet certain requirements, such as:
  • The ESOP must own 30% or more of the company immediately after the sale; and
  • The sale proceeds must be reinvested in qualified securities, including many publicly traded stocks and bonds. Reinvesting can also diversify your investment portfolio.
• For an S corporation, taxable income may be allocated from your individual income tax return to the ESOP. The ESOP is a tax-exempt entity, so there is no resulting tax liability on this income.
• The ESOP can serve as a buyer for your company should you lack a successor/buyer, or provide diversification liquidity, etc.

How does the ESOP work?

• The business owner can serve as a trustee and vote on behalf of the ESOP.
• You may sell your stock to the ESOP or the company may contribute stock to it.
• The trustee has a fiduciary responsibility to the ESOP.
• A bank can provide funding for the ESOP to buy the shares.
• A company will generally service the bank debt by making deductible ESOP plan contributions as a C or an S corporation. C corporations may also issue deductible dividends to the ESOP.

ESOP restrictions are similar to those of a qualified retirement plan

• Anti-discrimination requirements must be met, including limitations placed on owners in excess of benefits provided to other employees.
• There are plan administration requirements, such as providing information to employees and the IRS.
• Employees must be vested immediately or over a length of service based on regulations.

What are the costs of an ESOP?

• Plan administration, which tends to be more complex than just a qualified retirement plan.
• Redeeming the stock of departing employees entitled to cash.
• Obtaining an annual company valuation.

For more information, contact Brian Whitlock at 312-980-2941 or your Blackman Kallick representative. Our thanks to Tom Franklin for his assistance in writing this article.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.