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The Benefits of an Employee Stock Ownership Plan (ESOP) in Succession Planning

Succession planning can be a challenge for privately-held business owners. Finding the right buyer can be difficult and time consuming. In some cases, owners may want to transition their business to their current employees, but the employees may not have the financial means to consummate a sale. An Employee Stock Ownership Plan (ESOP) may be the solution. ESOPs can be very successful when implemented in the right situation, allowing owners to create sustainable and transferable value, and a well-prepared & successful exit, while at the same time deliver the best possible benefit to employees.

Primary Benefits of an ESOP Include:

Employee Stock Ownership Plan (ESOP)Benefits to Employers

  • Employers can, under certain circumstances, deduct contributions to the ESOP, including both interest and principal on loans the ESOP uses to buy the company stock. The company can also donate their shares of stock to the ESOP and get a tax deduction.
  • C Corporations can get a deduction for dividends paid to an ESOP used to repay loans, passed through to the participants, or reinvested in company stock.
  • The owner of the C Corporation can defer taxation of the sale of the stock to the ESOP by complying with Internal Revenue Code Section 1042 requirements.
  • S Corporation ESOPs do not pay taxes on their portion of the corporation’s income. The distributions paid to the ESOP can be used to pay down loans, fund benefits, or pay for administration expenses.
  • ESOPs can borrow money from lending institutions on employer credit to acquire the company stock. For owners who desire to pass the business on to employees, ESOPs makes this succession plan much more achievable.
  • Borrowed funds can be used to repurchase shares with pre-tax dollars.
  • Borrowed funds can be used to purchase new capital equipment needs, refinance other debt, purchase other companies, and for other business purposes.
  • In many cases, ESOP participants exhibit higher morale and productivity because they have a vested interest in the financial welfare of the business.
  • ESOP shares can be used to match employee 401(k) contributions, even under the safe harbor matching formula. This may make your 401(k) plan more attractive to employees, leading to greater participation. It may make it easier to comply with anti-discrimination testing requirements.


Benefits to Employees

  • Once an ESOP is established, employees are offered an additional benefit plan that is not taxable until they receive distributions, which is usually when they retire or leave the company. They can then rollover the distributions, tax-deferred, into an Individual Retirement Account (IRA).
  • ESOPs allow employees to have a vested interest in the financial well-being of the company on the same level as the original owners, even allowing them to vote their allocated shares on major issues.
  • ESOPs are similar to profit sharing plans, and can be valuable for those planning for their own retirement.
  • ESOPs can borrow money from lending institutions on employer credit to acquire the company stock. This alleviates the cash funding challenges employees may face if they were to buy the company on their own.

AAFCPAs advises commercial business owners to strongly consider the benefits of ESOPs for succession planning, to borrow money at a lower after-tax cost, or to create an exciting additional employee benefit. ESOPs can be an under-utilized tool because their benefits are not fully understood.

If you have questions or would like to learn more about the successful applications AAFCPAs has experienced over the last 40+ years, please contact your AAFCPAs partner or David Consigli at 774.512.4005, dconsigli@nullaafcpa.com.

About the Author

David Consigli
Dave is a leader of AAFCPAs’ Business Valuations Practice, specializing in valuations of closely-held businesses, business and ownership interests, and intangible assets.  He brings over 30 years of business valuation, transaction advisory, succession planning, and tax planning experience to AAFCPAs’ diverse clients.  His skills and expertise are highly sought-after by business buyers, sellers and lenders for the purpose of mergers & acquisitions, marital dissolutions, shareholder buyouts and disputes, buy/sell agreements, life insurance, and succession planning. Dave provides specialized valuation solutions that focus on assisting clients in addressing shareholder value optimization and portfolio valuations.  He is a member of AAFCPAs’ ESOP Consulting & Administration practice, advising commercial business owners interested in using employee ownership as a tax-efficient strategy for business succession planning. He also consults individuals and families on various divorce matters, including asset division, unallocated support, and child support calculations.

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