VIEWpoint Issue 1 | 2023
2023 Compliance Trends: Staying Ahead in an Evolving Regulatory E...
2023 Tax Calendar
Like many business owners, you want to retire someday. In addition, just about every business is looking for ways to improve employee engagement and retention. One ambitious and somewhat complex way to plan ahead, while also adding a benefit to employees, is by offering an employee stock ownership plan (ESOP).
An ESOP is a type of employee benefit plan, similar in many ways to a profit-sharing plan. To set up an ESOP, a company establishes a trust fund and contributes either new shares of its own stock or money to buy existing shares. The shares in the trust are then allocated to individual employee accounts (based on compensation or a formula that considers tenure), and the employees become vested in the accounts over a specified period of service years.
One reason for companies to establish an ESOP is to buy the shares of an owner who wants to retire. In many closely held or family owned businesses, there isn’t a family or staff member who’s capable of or interested in taking over when the founder is ready to leave. In such cases, the company can make tax-deductible contributions to an ESOP to buy the owner’s shares or have the ESOP borrow money to buy shares. Either way, the company enjoys tax advantages while helping to deal with the succession issue.
A retiring owner who’s cashing out over time will often keep a seat on the company board and retain voting rights during the transition. In this manner, businesses with ESOP-owned companies are often better able to keep valuable and experienced staff on board through ownership changes. In addition, an ESOP can serve to motivate staff because they are part owners.
The tax advantages of ESOPs are considerable. All contributions to the plan are tax-deductible, including shares of stock, cash contributions (whether they’re used to buy stock or to build up a cash reserve) and any payments made to repay loans taken out by the ESOP.
In addition, in C corporations, sellers are eligible for a tax deferral. If certain conditions are met (say the seller has held stock for at least three years and the ESOP owns at least 30% of shares), the seller can reinvest sales proceeds in qualified replacement property (generally, domestic stocks and bonds) and defer taxes on the gains as long as the rollover is executed within a specified time.
In S corporations, the percentage of ownership held by an ESOP is tax-exempt at the federal and usually at the state level as well. When an ESOP holds 30% of an S corporation’s stock, 30% of profits are tax-exempt. When the ESOP holds all of the S corporation’s stock, there’s no income tax owed on any of the company’s profits.
Last, ESOPs are allowed to borrow. When the plan does so to buy new or existing shares, the company can then make tax-deductible contributions to the ESOP in repayment. In such a case, both principal and interest are deductible.
Yes, ESOPs involve many facets, and establishing one isn’t in the best interests of every closely held company. Doeren Mayhew Capital Advisors works closely with owners to explore whether an ESOP is the most favorable solution for their business and its employees. To learn more, contact us today.
Securities offered through Doeren Mayhew Capital Advisors, LLC. Member FINRA/SIPC.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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