An ESOP is an Employee Stock Ownership Plan, a type of employee benefit plan, where an employer sets up a trust and contributes new shares of stock or cash to buy existing shares. Shares in the trust are then allocated to individual employees. When an employee leaves the company, he receives the stock and the company must buy the stock back from the employee at fair market value. If the company is privately held, an outside independent valuation is done to determine an appropriate price for the shares.
An ESOP has three uses: (1) to buy the shares of an owner who is leaving the company, (2) to borrow money at a lower “after tax” cost, or (3) to create an employee benefit. It is typically available to all full-time employees who are 21 and older. Allocations are made based on a specific formula and a vesting schedule applies. Employees must be 100% vested within three to six years of being added to the plan.
ESOPs offer employers several major tax benefits, including:
- Contributions of stock are tax-deductible.
- Cash contributions are tax-deductible.
- The ESOP can borrow money to buy existing shares, new shares or treasury shares. Contributions used to repay an ESOP loan are tax-deductible.
- Sellers in a C corporation can get a tax deferral.
- In S corps, the percent of ownership held by an ESOP is not subject to income tax at the federal level.
- Dividends are tax-deductible.
- Employees do not pay tax on the contributions to an ESOP, but they will pay tax on the distribution.
As with every employee benefit plan, there are rules, regulations and limitations. To determine if an ESOP is right for your company, call Synergetic Finance at 206-386-5455 or email us today.
To your wealth,
Joe Maas, CFA, AVA, CFP®, ChFC, CLU®, MSFS, CCIM
President of Synergetic Finance