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.
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.
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.
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.