ESOP Tax Benefits for Companies

Companies can benefit from a number of tax advantages from employee stock ownership plans (ESOPs). These benefits include:

  • Deductibility of ESOP contributions: Companies can deduct contributions to an ESOP trust from their taxable income, up to 25% of covered payroll. This can help to reduce a company’s tax liability and improve its bottom line.
  • Tax-free dividends: Dividends paid to ESOPs are tax-free to the company, as long as the dividends are used to repay ESOP loans or are passed through to employees. This can help to save companies a significant amount of money in taxes.
  • S corporation exemption: S corporations that have ESOPs are exempt from federal income tax on the portion of their profits that are attributed to the ESOP. This can provide S corporations with a significant tax advantage.
  • Deferred capital gains: Shareholders who sell their company’s stock to an ESOP can defer capital gains taxes on the sale proceeds. This can help shareholders to save money in taxes and to transition ownership of the company to employees in a tax-efficient manner.

In addition to these tax benefits, ESOPs can also help companies to improve employee morale and productivity, reduce turnover, and attract and retain top talent.

ESOP Tax Benefits for Sellers

Small business sellers can receive a number ESOP tax benefits.

  • Seller tax deferral: Sellers who own at least 30% of the company stock can defer capital gains taxes on the sale of their shares to an ESOP trust.
  • Capital gains tax rates: Stock sales to the ESOP are taxed as capital gains.

ESOP Tax Benefits for Employees

Employees benefit the most from ESOPs by design. The 1974 ERISA legislation gives employees significant tax breaks on earnings from ESOPs, and subsequent legislation added to these advantages.

  • Tax-deferred growth: ESOP assets grow tax-deferred, meaning that employees do not pay taxes on the appreciation of their ESOP shares until they are withdrawn from the plan.
  • Capital gains tax deferral: Once employees sell their shares of stock, they may be able to defer or eliminate capital gains taxes on the sale if they reinvest the proceeds in another qualified retirement plan within 60 days.
  • Dividends: Dividends paid on ESOP-owned shares are tax-exempt to employees.
  • Loan repayment: Employees can use tax-free distributions from their ESOP accounts to repay ESOP loans.
  • Exemption from estate taxes: ESOP-owned shares are exempt from estate taxes, up to $1 million per employee.

Benefits for Employees Beyond Taxes

There are huge benefits to ESOPs for employees that go beyond the monetary benefits.

  • Increased employee engagement and productivity: Employees who own a stake in the company they work for are more likely to be engaged and productive.
  • Reduced turnover: Employees who own a stake in the company are more likely to stay with the company for the long term.
  • Improved financial performance: ESOPs can help to improve the financial performance of a company by increasing employee engagement and productivity.
  • A more equitable distribution of wealth: ESOPs can help create a more equitable distribution of wealth by giving employees a stake in their company.