Updated: Jan 31, 2019
An owner, who wishes to sell an interest in either his closely held corporation or S corporation, but does not have a current buyer, may use an Employee Stock Ownership Plan (ESOP), thus creating a market for his company’s stock. This special type of qualified retirement plan may be established for the benefit of the employees of the corporation.
Employer Stock Ownership Plans for Buy/Sell Purposes
An ESOP, unlike a traditional qualified plan, may invest in the employer’s stock. An ESOP may be a combination of either a Stock Bonus Plan and Money Purchase Plan, or a Stock Bonus Plan standing on its own. These types of ESOP plans have been designed to include the various tax and regulatory requirements of an ESOP.
The owner, in an effort to create a market for his business, can arrange to sell his shares of the corporation to the newly formed ESOP. The ESOP is formed by the corporation exclusively for the benefit of its employees and funds the plan with tax-deductible cash contributions. Then, the cash is used by the ESOP to purchase qualifying employer securities from the shareholders. These shareholders may either remain with the company or retire.
ESOPs may use borrowed funds from either the employer, shareholders, or third parties in order to purchase the stock. The loans are exempted from the Prohibited Transaction rules. If an ESOP holds S corporation stock, it will be counted as a single shareholder for the 100 Shareholder Limit, regardless of the number of ESOP participants.
The employees’ accounts are allocated with the stock acquired by the ESOP, typically on the basis of compensation earned. The amounts of money allocated to the employees’ accounts are not taxable to the employees when the contribution is made. The contributions will accumulate on a tax-deferred basis until the employee either retires, becomes disabled, dies or otherwise terminates employment. The recognition of income will occur when the employee or beneficiary receive the stock or at the time the stock is sold and the proceeds are distributed to the employee.
Since ESOPs are far more complicated than your traditional employee retirement plans, it is always best to utilize professionals when either determining if a plan meets the company’s and shareholders’ objectives or at the time a plan is decided upon and installed.