ABRC-ESOP

Evan L. Rhodes: In the last several years, there has been a steady increase of businesses forming as, or converting to, an L.L.C. structure. While this structure is called a corporation, its legal structure is closer to that of a partnership. Since there is no issuance of stock in an L.L.C., you cannot directly install an ESOP in an L.L.C.

Since S-Corps and the L.L.C. are taxed identically, the advantage lies with the S-Corp and its ability to be tax-exempt through utilization of an ESOP. The L.L.C. provides more personal liability protection to ownership compared to the standard S-Corporation. However, an S-Corp ESOP provides liability protection at least equal to and possibly greater than the L.L.C.

An S-Corporation can be a member of an L.L.C. Since an L.L.C. is a flow-through tax entity, the tax burden on the income of the L.L.C. (K-1) passes through to the S-Corporation. The S-Corporation is taxed on those proceeds based on the tax rate of its shareholder. In the event the S-Corporation's shareholder is the tax-exempt ESOP, then all proceeds received from the L.L.C. are also tax-exempt. It is clear that there are many potential benefits involved from converting or combining tax-exempt S-Corporations and L.L.C.'s.

Evan L. Rhodes: Many companies use ESOPs as another benefit they can offer in a competitive labor market. Companies with a 401(k) use the ESOP as one more lure. Many employers tout the fact that they are employee-owned in their recruitment ads and corporate web sites. Generation-X’ers don’t work for just a paycheck; they want an equity stake in something they are helping to build.

Evan L. Rhodes: There is considerable research linking ESOPs to substantially improved corporate performance. The company becomes a major portion of the employee’s retirement plan and everyone has a stake in it. Improved corporate performance benefits everyone, not just the owner.

Evan L. Rhodes: An ESOP can make your company tax exempt. At the 40% tax rate, this equals a 66% increase in cash flow which can be used to buy other companies, buy new equipment, or any other corporate purpose. As long as the money is left in the company to fund growth, you never pay any taxes on it or on the earnings resulting from the growth.

Evan L. Rhodes: An ESOP allows owners of closely held companies to sell to an ESOP for the full fair market value. The government subsidizes the sale by allowing the company to become tax-exempt thus the dollars that previously went to pay taxes may be used to fund the purchase.

Evan L. Rhodes: A good TPA will:-Collaborate with your ESOP consulting firm to review your options and assist in building a plan that meets your needs

-Constantly monitor Internal Revenue Service and Dept. of Labor Regulations to determine their options for and effect on existing and newly created ESOP plans

-Analyze employee census information to determine eligibility for each plan year

-Conduct Department of Labor and/or Internal Revenue Service audits of your ESOP plan from their office trustees, investment advisors, and attorneys involved with the plan.

Evan L. Rhodes: Business Owners who wish to:
-Infuse working capital into the company by reducing tax liability
-Provide capital for family members who have taken over the business
-Acquire another company with pretax dollars
-Induce employees to remain with the company
-Create private market for company stock
-Increase employee productivity and thereby increase company profitability
-Improve the effectiveness and reduce the cost of employee benefits including pension and profit-sharing plans
-Sell or merge the company to employees or select management team
-Sell or merge the company to family members
-Sell or merge the company to outside third party
-Put in place a controlled exit strategy from the company
-Eliminate corporate taxes and increase cash flow
-Cash out one or more shareholders and avoid capital gains tax
-Recover taxes paid in prior years
-Refinance existing debt, making both principal and interest tax deductible

Evan L. Rhodes: The S-ESOP should only be considered by business owners who have a profitable business, have more than ten employees, want to keep the business going, and keenly understand the difference between ownership and control. In general, professional corporations that require the shareholder to be licensed in that industry, such as medical and legal professions, cannot become an ESOP. When properly designed, the S-Corp ESOP can help lower taxes, increase cash flow, motivate employees and best of all, fund your exit.