ABRC-ESOP

There are many different reasons business owners install ESOPs in their companies. Until 1998, ESOPs were only available to C-Corporations, both public and private. In 1998 they also became available to S-corporations.

In public corporations (C-Corps) they were used primarily as a way to provide deductible non-cash benefits to employees or in exchange for employee concessions (wage, benefit, etc).
In smaller private C-Corporations they were primarily used as an exit strategy for a retiring shareholder that otherwise had no market for their company. There is a tax advantage available to both the seller and company. The company is able to deduct payments on the purchase price from corporate earnings and the seller can reinvest the proceeds and receive a tax deferral under certain circumstances.
While this allowed for a deduction of the purchase price for the company, it can still create a cash flow challenge for the company, as all other taxes are still due on earnings other than those related to the payment.
In 1998 it became possible to install an ESOP in an S-Corporation. This revolutionized the ESOP world in that the structure of an S-corporation allowed for the opportunity to eliminate income taxes on all corporate earnings, not just those related to the purchase of the company. The excess tax savings can then be retained in the company.

In recent ESOP conferences I have attended, an unscientific poll (raise of hands) was conducted to determine how many of the companies present were S-Corporations ESOPs (75%). Of those, how many were structured to be 100% tax exempt, again 75%. The last question was how many had made an acquisition of another company or were in the process of doing so in the last 18 months. The response was a surprising 50%.

The creation of the S-Corporation ESOP has changed the landscape of the ESOP world and are beginning to impact other non-ESOP companies.

We will be exploring these and other related issues in future postings.

If you are an ESOP company, did you do it for the purpose of acquisition, exit, growth , recruiting or other?

Over the next week or so we will be discussing the importance of communicating the ESOP and its benefits to employees, along with some tips on how to get your message across.