Employee Stock Ownership Plans

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Inevitably, a leveraged buyout to management or outside parties may strap a business with debt that decreases the business’ chance of success and growth. This being the case, a business owner may consider selling a business to its employees, using employee stock ownership plans (ESOPs) to finance part of the purchase while retaining control by management. The purchase of part of a company’s stock though an ESOP can be done on highly preferential terms, thus making the buy-out easier to complete.

Essentially, an ESOP is an employee retirement plan that invests all of its assets in the company’s stock. The stock is held in trust by a trustee that is appointed by the company’s board of directors. If a business owners sells the company to the employees, the loan to purchase the company is made to the ESOP, a qualified retirement plan, therefore allowing the payment of the note to be paid with pre-tax dollars. Assuming that other buy-out options do not have the benefits of making principal payments in pre-tax dollars, an employee purchase using a ESOP provides a much lower cash cost of purchasing the business.

In addition to tax incentives for potential buyers, the selling business owner may receive considerable tax breaks. In particular, the owner may defer the payment of capital gains taxes if these three criteria are met:

  • The stock has been owned for more than three years.
  • The proceeds are invested in domestic operating companies.
  • The ESOP owns at least 30% of the shares.

This results in the business owner being able to sell the company, invest 100 % of the proceeds into other domestic operating companies and defer 100% of the capital gains taxes. If the business owner eventually sells the replacement domestic operating stock, the taxes would become due. Although business sales to employees using ESOPs can provide significant benefits to both sellers and buyers, these types of succession plans require a significant amount of advanced planning.

If you are interested in exploring the possibility of setting up an employee stock ownership plan, the professionals at CGT Solutions have the knowledge and experience necessary to help you successfully complete the task. Our staff has helped many businesses set up employee stock ownership plans as well as advising them in other areas of tax and long range financial planning. Contact us today to schedule a free, no obligation consultation!

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