Every employee wants to know if he
or she will be able to retire comfortably. But, there are many retirement plans out there, and navigating them can
be cumbersome and time-consuming.
Because of this, many companies shoulder the burden for their employees, offering various options designed to prepare
employees for their golden years.
One such plan is the Employee Stock
Ownership Plan (ESOP), which is similar
to a stock bonus plan or money purchase
plan. ESOPs are intended to invest first
and foremost in the employer’s stock,
instead of mutual funds or publicly traded stock, according to Rene Lozano, CPA,
a manager in the tax department at Briggs
& Veselka Co. Essentially, these plans are
set up to purchase stock from the private
company owner.
“ESOPs were created by Congress in
1974 to help supplement retiree income,”
Lozano says. “Since that time, these plans
have been used by the likes of Microsoft
and General Electric. They can be very
beneficial to both employees and employers.”
Smart Business spoke with Lozano
about ESOPs and how companies can utilize them to ensure prosperous futures.
What are the benefits of ESOPs?
ESOPs have a number of benefits. First
and foremost are the tax benefits. A plan
can also help a business owner diversify
his or her investment. And ESOPs can
even help increase employee productivity
and retention.
The owner of a private company can
defer the gain on the sale of his or her
stock to the ESOP if he or she sells at
least 30 percent and the corporation is
not classified as an S corporation. To
defer the gain, the seller will also have to
reinvest the proceeds in other stocks or
bonds. As an added benefit, the owner of
the private company is diversifying his or her investment in other stocks or bonds.
The company will also be able to take a
tax deduction of up to 25 percent of eligible employee wages when the company
contributes to the plan. If the company is
an S corporation it will not have to pay
any federal income taxes on the ESOP’s
share of the company’s profits. In fact, a
100 percent ESOP-owned S corporation
will not pay any federal income taxes on
company profits. The reduction in taxes
generally helps to increase cash flow and
is often used to help pay for the ESOP
contributions.
ESOPs give employees a direct stake in
their own output. This connection helps
to increase employees’ productivity, and
they are also more likely to control costs
and reduce misconduct.
What problems or issues can arise from
ESOPs?
Owners of private companies with S
corporation status are not eligible for the
tax-free rollover when they sell their
shares to an ESOP. This can be avoided by converting into a C corporation; unfortunately, the change will cause the company to pay corporate income taxes for at
least the next five years. A company will
also not be able to deduct more than 25
percent of eligible employee wages to the
ESOP. So, any portion of contributions
made in excess of the 25 percent is not
deductible by the company.
How can the problems be solved?
Most or all issues related to an ESOP
can and should be avoided with proper
planning. Excess nondeductible contributions can be avoided in this way. The
owner can also avoid taxes on the sale by
reinvesting the proceeds.
What are the consequences a company
faces?
ESOPs have the ability to take out loans
to purchase company stock. A loan may
not be the proper course of action if the
company is not profitable enough to
make loan payments and repurchase
shares from employees retiring or leaving
the company.
What is the resolution to all this?
ESOPs can and should be used as a tool
to help private owners and their companies in a variety of ways. A properly executed ESOP will benefit the owner and
the company. The owner has the ability to
retain control of the company in a sale. A
seller of less than the entire company will
often find himself owning a smaller share
of a larger company. And, employee ownership will also help to increase productivity while increasing overall company
value.
RENE LOZANO, CPA, is a manager in the tax department at
Briggs & Veselka Co. in Houston. Reach him at (713) 667-9147
or [email protected].
