Benefits Of The ESOP To C Corporations
Benefits Of The ESOP To S Corporations
An Employee Stock Ownership Plan (ESOP) is an IRS qualified
benefit (defined contribution) plan designed to invest primarily in employer stock.
To establish an ESOP a company sets up a trust to hold
the assets and makes contributions to it of company stock or cash. Each employee
participates by receiving a contribution based on his or her earnings. The employee
receives a contribution without him or her making any cash outlay, any reduction in
pay or losing any other employee benefits.
When the company makes cash contributions to the ESOP,
the company or a shareholder can sell his or her stock to the ESOP and receive
When a shareholder of a C Corporation sells his or her
stock to an ESOP, the transaction can be designed so that the shareholder defers capital
gains tax on the cash received from the sale. The financial benefit of this tax deferred
(possibly tax free) sale is that the selling shareholder will retain 15% - 25% more gain.
The contributions a company makes to an ESOP are tax deductible up
to 25% of the payroll of the participants in the plan. The ESOP also can borrow funds to
buy new or existing shares of company stock, when it does borrow money, the tax reduction
benefits increase (for both C & S Corporations).
For C corporations tax deductible contributions of up to 25% of
payroll may be used to repay the principal on the ESOP loan, plus interest payments can
be paid with no payroll percentage limitations. Also, reasonable dividends from company
stock used to repay debt have no payroll percentage limitations and are usually tax
For S corporations, in addition to the 25% of payroll maximum
deductions, the company is not taxed on S corporations earnings that are attributed to ESOP
stock. The higher percentage of stock owned by an ESOP in an S corporation the less S corporation
taxes are owed. For a 100% S corporation ESOP the company could be tax exempt!
Through an ESOP, a corporation can use tax deductible dollars
for making company improvements, corporate expansion or using capital for other needs. When
tied to an ESOP, corporate debt payments of both principal and interest are tax deductible.