What Is an Employee Stock Ownership Plan?
Specifically, an ESOP is an employee benefit plan that allows businesses to sell off ownership shares of the company directly to employees. Typically, these company shares are acquired through an employee retirement account; when the worker decides to retire or otherwise leave the company, the business buys the shares back from the employee.
Businesses can choose to sell off part or all of the company’s shares through an employee stock ownership plan; this type of plan is relatively flexible and versatile, allowing both businesses and employees to reap the benefits.
Benefits of ESOPs for Businesses
There are many potential advantages for businesses that choose to implement an ESOP option as part of their employee benefits—but these will vary based on business structure and other factors.
C corporations, for example, can enjoy a tax deduction for all dividends paid on a stock (so long as the dividends are distributed right away and meet the terms of the plan itself). This means that C corporations with ESOPs in place have the ability to deduct dividends paid for significant tax benefits. Meanwhile, C corporation ESOP sponsors also have the ability to deduct 100% of the contributions used to repay ESOP loan interest.
S corporations, on the other hand, can benefit from ESOPs in other ways. Consider, for example, that ESOPs sponsored by S corporations are not subject to federal income tax. In fact, no taxes are paid on distributed cash until a distribution is required due to an employee retiring or otherwise leaving the company. Without this tax burden, S corporations may have an easier time maintaining balance sheets while sponsoring an ESOP option for employees.
For all businesses offering an ESOP, another advantage to consider is that this type of option can help employees become more vested in the success of the company itself. This, in turn, can help to keep employees motivated and focused on improving performance and making decisions for the good of the business overall.
Benefits of ESOPs for Employees
For employees, there are also a number of potential benefits of ESOP options. First and foremost, ESOPs allow employees to gain ownership of the company for which they work while enjoying an added retirement benefit. At the same time, employees enjoy the convenience of not having to make their own contributions directly to the ESOP.
Meanwhile, taxes for employees are not paid until distribution occurs, so employees can enjoy tax-deferred earnings until they retire or leave the company. All of this allows employees to increase their equity in a company while potentially enjoying a greater sense of job satisfaction in the process.
Considerations for Business Owners
For business owners considering the option to offer an ESOP to employees, there are some things worth taking in account and planning for in advance. First, for those thinking about selling part or all of their business shares to employees, exit planning with a financial planner is an absolute must.
Employers must also take into account that there are strict federal regulations and other corporate tax laws that will apply to an ESOP. Taking the time to thoroughly research and understand these tax laws will help businesses determine which apply to them based on company structure and other key factors.
ESOPs also require ongoing maintenance and administration, which is why it’s important to consult with a financial advisor or another professional who will understand how to properly structure an ESOP (and make changes to the plan as needed in the future).
Last but not least, ESOPs are not an ideal employee ownership option for all businesses. There are a number of other ownership options, purchase programs and other solutions that may better suit a company based on a variety of factors. Some common alternatives to an ESOP include:
- Phantom stock
- Restricted stock
- Direct stock purchase plan (DSSP)
- Stock appreciation rights
The Final Word on ESOPs
For many businesses, including C corporations and S corporations, an ESOP can be a great way to offer additional benefits to employees while reaping a number of tax advantages as well. At the end of the day, however, there is a lot of planning that must go into launching and maintaining an ESOP—which is why having a trusted financial advisor or consultant is a must for any growing business considering an ESOP. With a little help and guidance from one of these professionals, businesses can get the help they need in determining whether this is the right plan for them. From there, they can also receive assistance in setting up and maintaining the plan for years to come.
Contact Frankel to learn more about how we can support your business at www.frankel.cpa or call us at (402) 469-9100.
