Tax Advantages of ESOPs

Taxes make the world go round. So, it's no surprise that ESOP experts and tax consultants have figured out how to tap into the many tax advantages of ESOPs. If you've been considering the benefits of an ESOP, these tax perks may push you over the edge.

Corporations have a growing awareness of the benefits connected with employee stock ownership plans.

A well-crafted ESOP motivates employees and provides financial incentives for both the corporation and its key shareholders.

ESOPs are designed to give employees an ownership share in the business. Congress has taken a special interest in promoting this form of employee incentives and has subsequently enacted tax code legislation that makes ESOPs an irresistible option for many companies.

Although tax benefits aren't the only reason for setting up an ESOP, provisions contained in the current tax code can substantially impact your corporate earnings statement and balance sheet

  • ESOP contributions. An ESOP is considered a tax qualified employee benefit plan, so contributions made to an ESOP are tax-deductible for the corporation. Contributions can be made in either stock or in cash (which will be used to purchase stock). If corporation opts to make direct stock contributions, the full value of the stock is deductible.
  • Leveraged ESOPs. Leverage ESOPs present some unique tax opportunities. By flowing the principal and interest payments related to the repayment of lender financing through an ESOP, the corporation is allowed to effectively deduct both principal and interest. In a typical repayment scheme, corporations would only be able to deduct the interest portion of financing for capital purchases or owner buyouts.
  • Exit rollovers. Employee stock ownership plans have become particularly attractive to owners or key shareholders who are eyeing a cost-effective exit strategy. If the owner simply sold his stock back to the company or to another business interest, the proceeds of the sale would be taxed as ordinary income or in certain cases, as a capital gain. If the owner sells his stock to an ESOP and reinvests the proceeds in a security, the sale is untaxed. In essence, the owner or shareholder receives a tax-deferred sale benefit.
  • Dividend deductions. If the company is classified as a C corporation, it can deduct dividends that are paid on stock that has been purchased with an ESOP acquisition loan–but only if the dividends are passed through to the company's employees.

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