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Employee Stock Ownership Plans
An ESOP (Employee Stock Ownership Plan) is a tax-qualified employee benefit plan that can also be used to provide benefits for the sponsoring company and its ownership. It is the only employee benefit plan that can own employer securities and borrow money. These abilities allow the plan to also serve as a tool of finance.
The principals and associates at Financial Consulting Group have consulted with companies to achieve their goals and provide for their employees using the unique features of ESOPs since the late 1980s.
An ESOP can also be combined with a 401(k) to create a KSOP. The advantage of the KSOP is that employee money deferred under the 401(k) feature, to the extent designated by the employees, can be used to achieve the financing objectives of the plan. Effectively, the 401(k) feature increases to capacity of the plan to purchase employer stock.
Some common financing uses for ESOPs and KSOPs are:
Creating a Market for Company Stock
Many privately held businesses do not have a market for their stock. An ESOP or KSOP can often create an effective market. If the company already has a commitment to fund a retirement plan, those dollars can be used to create a market at no additional cost. Even if additional funds are contributed to the plan to affect a stock purchase, the contributions are tax deductible providing a discount on the purchase equal to the company’s tax rate.
A company may choose to issue stock to the plan and use the proceeds to repay debt. The contributions used to purchase the shares are deductible, effectively making the debt principal tax deductible.
Subchapter S Taxpayers
Sub S companies do not pay taxes themselves, but pass through that liability to their shareholders. In order for the shareholders to have the cash to pay the tax, Sub S companies typically dividend a large portion of the income, 30% – 35%. ESOPs and KSOPS are non-taxable trusts and do not pay tax on their share of these dividends. This benefit can allow the company to reduce its retirement plan contributions and still provide excellent retirement benefits for the employees.
Sale of the Business
In some cases it may be desirable to sell all or a portion of a business to the employees. This may be part of a business exit or succession strategy, or it may be for certain other specific reasons. For example, certain companies that have favorable government contracts can lose favored treatment if they sell to larger businesses. These benefits are retained in a sale to the employees. Finally, if certain requirements are met, the seller can defer income taxes on any gain, reinvest the proceeds and only pay taxes when the reinvestment securities are sold or mature.
Many companies have adopted ESOPs or KSOPs in the belief that having at least some employee ownership will increase motivation and cause employees to think and act more as owners. Implementing and using ESOP and KSOP is a process that must be tailored to the specific needs of a company and its employees. This requires knowledge in finance, tax and the law. Financial Consulting Group has the in-house expertise to deliver this knowledge.
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