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The Benefits of an ESOP Plan
November 29, 2011
An employee stock ownership plan, commonly referred to as an ESOP, is a qualified employee benefit plan governed by ERISA (the Employee Retirement Income Security Act). ESOPs are similar in many ways to 401(k) plans and profit sharing plans. All of these plans operate through a trust, require that their benefits be provided on a nondiscriminatory basis to employees, and provide both the sponsoring employer and the employee with significant tax benefits. Unlike 401(k) plans, however, ESOPs are almost invariably funded entirely by the company, and, unlike all other retirement plans, they are intended to be invested primarily in employer securities. They also are unique in their ability to borrow money.

ESOPs have been granted a number of tax benefits that go beyond those normally available to retirement plans. Contributions of principal as well as interest used to repay debt borrowed by the ESOP are deductible. In addition, dividends paid on the stock acquired by the plan may be deductible as well. Congress has seen the growth of broad ownership as good economic and social policy, a view that has been borne out by research showing that ESOPs generally enhance corporate performance and employee financial security.

ESOPs are used for a wide variety of purposes:
  • The most common application for an ESOP is to buy the shares of a departing owner of a closely held company. In C corporations, owners can defer or eliminate taxes on the gain they make from the sale to an ESOP if the ESOP holds 30% or more of the company’s stock and certain other requirements are met. Moreover, the purchase can be made in pretax corporate dollars.
  • ESOPs are also used to divest or acquire subsidiaries, buy back shares from the market (such as in the case of public companies seeking takeover defenses), or restructure existing benefit plans by replacing current benefit contributions with a leveraged ESOP (i.e., one that borrows money).
  • ESOPs can purchase newly issued shares in the company, with the borrowed funds being used to buy new productive capital or finance an acquisition. The company can, in effect, finance growth or acquisitions with pretax dollars while these same dollars create an employee benefit plan.
  • The above uses generally involve borrowing money through the ESOP, but a company can simply contribute new shares of stock to an ESOP, or cash to buy existing shares, as a means to create the plan.
These are some of the benefits of establishing an ESOP plan. Contact us if you would like to learn more about this type of plan.
Federal Taxation Wills, Estates & Trusts