ESOP & the Next Generation

Quick Summary
An employee stock ownership plan (ESOP) is a retirement plan with a twist: investments made to the plan are primarily ownership shares in the employees’ company. This gives workers a powerful incentive to save for retirement and a stake in their companies’ future fortunes, making this a unique benefit.

How to Transfer Your Company to Employees With an ESOP

For many business owners, an ESOP provides a ready market – their own employees – of potential buyers of their businesses. Because it is also a “qualified” retirement plan, an ESOP offers workers tax advantages. Contributions made on their behalf aren’t taxed until they withdraw them.

What Are The Advantages of Selling to Employees

When buyers are unqualified and pay for your business in installments, you risk your future retirement income stream and your company’s legacy. Betting on your former company’s future revenues is risky, but ESOPs reduces much of that risk. First, your employees are generally motivated and knowledgeable buyers. Second, an ESOP can pay a good part or all of your company’s sale price up front.

ESOP’s Capital Gains Tax and Tax-deductible Contributions

Because an ESOP is a qualified plan, participants in these plans receive special tax breaks on stock contributed to their accounts by employers. For example, investment earnings are not taxed until they take distributions. Employers sponsoring an ESOP also get tax breaks when issuing new shares, making cash contributions, and paying back loans to their ESOP. They also pay a typically lower capital gains tax when selling stock to the plan, subject to certain conditions.

Factors to Consider when Establishing an ESOP

ESOPs aren’t the right solution for every business. They are typically expensive to start up and time-consuming. They are also highly regulated by both the Department of Labor and the Internal Revenue Service. An ideal ESOP sponsor has strong and stable earnings and sales, with ready and able management in place to give current and future owners the greatest chance of continued success.
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