ESOPs provide many tax advantages. An ESOP is really a retirement plan under which a trust acquires the employers stock in trust for the employees. The ESOP trust will choose the employer’s stock from the employer or the employer’s shareholder. The ESOP will acquire this stock by finding a bank loan. The lender loan is guaranteed by the employer. The employer can make yearly tax deductible cash contributions to the ESOP. The ESOP use this cash to create payments on the loan. The ESOP will distribute shares of the employer’s stock to employees relative to the plans distribution requirements.
The ESOP is tax advantageous over other stock purchase mechanisms as the employee’s tax obligation is deferred before employee sells the employer’s stock. The employee will not pay tax during the employer’s cash contribution or once the stock is distribution from the ESOP plan. The employer receives current deductions for the money contributions to the program or for stock contributed to the program.
The main disadvantage of an ESOP is an employer must adhere to numerous ERISA requirements which are imposed upon retirement plans. These requirements relate with who should be covered, when are participants vested, just how much is funded, reporting, disclosure, etc. Creation and maintenance of the program could be expensive.
Also, adoption of an ESOP means that you need to share ownership of one’s corporation. This raises the potential problems discussed above.
An ESOP does give a market for the stock, however. If your goal would be to sell your corporation, instead of to talk about ownership, having an ESOP could possibly be revisited. You should possibly get yourself a significant cash payment for several of one’s stock. Needless to say, the payment (minus your basis in the stock) will be taxed at capital gains rate.
Before adopting an ESOP to buy your entire interest, you ought to be look at a sale of the business enterprise to an authorized. The after tax cashflow of both alternatives ought to be compared.