Sue Odom – ESOPs Jan 23 2014

By Sue Odom
Nexsen Pruet
January 23, 2013 

1.An ESOP or Employee Stock Ownership Plan is a qualified retirement plan, like a 401(k) plan, except the investments primarily are in company stock.

2.Most business owners consider establishing ESOPs as succession planning tools when there are no family members or business partners in line to take over after retirement.

3.When employers want to incentivize employees by giving them company stock, an ESOP is an option to consider, but only if most employees would be eligible for the benefit.  An ESOP cannot be established only for a select group of key employees.  Instead, restricted stock, phantom stock, and stock option plans might meet the company’s business goals.

4.Selling shareholders who qualify for Section 1042 treatment can defer taxation on the gain in their stock if they reinvest the proceeds in qualified replacement property (domestic stocks or bonds; not mutual funds) within 12 months of the sale.  Upon death, their heirs or devisees will receive a stepped-up basis in these investments, completely eliminating the unrecognized gain.

5.Selling shareholders who elect Section 1042 treatment are restricted from participating in the ESOP.

6.The Company can finance the ESOP’s purchase of shares on a fully tax-deductible basis because contributions made to fund both the interest and principal on an ESOP loan are tax-deductible.

7.100% ESOP-owned S Corporations pay no federal income taxes.
8.Establishing an ESOP does not mean that control over the company must be given to employees.  Often the selling shareholders retain an on-going ownership interest and/or management role in the company and also serve as ESOP trustees.

9.Participating employees have special diversification, voting, demand, and put option rights in ESOPs.  Demand rights may be avoided for Subchapter S corporations and corporations who amend their organizational documents to restrict ownership to employees or the ESOP trust.

10.On a stock sale, the ESOP trustee would vote the shares owned by the ESOP, assuming they are not registration-type securities.  However, in an asset sale or a merger, the voting rights on allocated shares would pass thru to the ESOP participants.

11.Participant lawsuits involving ESOPs mostly allege fiduciary breaches, resulting in the drop in value of their company stock.

12.ESOPs are expensive to establish and relatively complicated and costly to administer.  So, they are not a good fit for every company.

Sue Odom

Sue Odom is member (Partner) at Nexsen Pruet in Columbia.  Her tax law practice is focused on the area of ERISA, employee benefits, and executive compensation. She works extensively with employer-sponsored benefit plans.