When business owners seek to sell their ongoing enterprises, all too often they gaze past a knowledgeable, capable, and logical group of purchasers: The employees. While structuring a sale to employees, instead of other investors, can bring with it a set of business and legal issues, it might also be the perfect ticket to provide the owner with a means to cash out – in whole or in part – of the day-to-day operations, all the while helping assure that the employees keep their jobs.
In a typical employee stock ownership plan (ESOP), the company establishes a trust, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow to fund the purchase of new or existing shares. Where there is a loan, the company transfers cash to the plan from time to time to enable it to repay the loan. The important thing to note: No matter how the ESOP acquires stock, company contributions to the trust are tax-deductible, within certain specified limits.
Many experts in tax and business succession planning tout the power and flexibility of an employee stock ownership plan. It can save headaches and taxes, all at the same time. For example, in an outright sale of a $4 million business, if the long-time owner had a tax basis of, say $400,000, he or she would expect to write a huge check to the U.S. Treasury, since the gain would amount to $3.6 million. Structured correctly, much of the tax on that gain could be avoided, or at least postponed, through an ESOP transaction.
An important additional benefit is the fact that the ESOP allows employees to take an ownership interest in the company. From a management standpoint, an ESOP can be a very useful tool for aligning key employees’ interests with those of the owner. The ESOP allows an owner to transfer control gradually to a new management group.
Not only can ESOPs provide for gradual transition of management to a new group of owners, they can offer other advantages, including the following:
ESOPs aren’t for everyone. They may not be utilized when it comes to businesses that operate as partnerships. Most professional corporations are also barred from the use of ESOPs. “S Corporation” ESOPs have lower contribution limits and other limitations.
An ESOP is a qualified plan under ERISA and must be maintained according to a myriad of federal (and state) rules and regulations. Some businesses find the expenses of administration too high, considering the benefits to be achieved.
On the other hand, many business experts stress that the positive impact on employees can be significant. With the ESOP, employees have the opportunity to participate in the success of the company. You should consult an adviser experienced with establishing ESOPs to determine if this solution may help you achieve your long-term goals for retirement and your company’s future.
Are you considering a sale of your business? Do you have succession planning issues that need to be addressed within the next few years? Is your tax basis in your business so low that you are concerned about the federal income tax ramifications that would flow from a sale? The attorneys at Romano & Sumner have more than 20 years of combined experience providing expert legal assistance to clients in all types of complex business, wealth management, tax planning, and asset preservation issues. We represent many family-run businesses and have intricate knowledge of the delicate issues that can arise.
At Romano & Sumner, we pride ourselves not only upon our professionalism, but also upon our client service. We know that each situation is unique. We return phone calls within one business day. We keep clients informed. We complete the work within the allotted time frame. Call us at 281-242-0995 or complete our online contact form.
Romano & Sumner – Sugar Land, TX Attorneys