EMPLOYEE STOCK OWNERSHIP PLANS
What is an
An ESOP is a type
of profit sharing plan that invests primarily in the stock of the
sponsoring employer and provides for benefit distributions in the
form of employer stock.
How does it
The employer can
contribute stock instead of cash to the ESOP as its plan
ESOP also can use the proceeds of a loan guaranteed by the
employer to buy employer stock.
How does an
ESOP loan work?
In a "leveraged"
ESOP, loan proceeds go to the ESOP, which buys employer stock.
The employer repays the loan by making cash contributions
to the ESOP, which in turn pays off the lender.
Why is an ESOP
loan any better than a conventional loan?
When an employer
makes cash contributions to the ESOP, the entire contribution is
deductible for tax purposes.
This means both principal and interest payments are
conventional financing, only the interest payment is deductible.
Are there any
other ESOP tax advantages?
shareholder can indefinitely defer tax on the sale of his stock to
an ESOP by buying securities of any domestic operating company
with the sale proceeds. A
specific tax provision also excluded 50 percent of interest paid
on an ESOP loan from the income of the lender.
What are the
disadvantages of an ESOP?
"pass through" voting rights
stock value because of obligation to repay ESOP loan
obligation to repurchase stock from participant accounts upon
retirement, separation from service and reaching age 55 with ten
years of ESOP participation
costs, both initial and ongoing
Who needs an
Any business owner
considering retirement or his estate plan can be an ESOP candidate.
An ESOP may be the best way to allow a business owner to
"cash in his chips" and at the same time provide for
continuity of management.
What does a
commercial lender need to look at when considering an ESOP loan?
Employer assets to
provide adequate security and sufficient payroll to fund loan
employer's repayment is made by ESOP contributions and those
contributions are generally limited to 25 percent of the aggregate
compensation of ESOP participants.
new with ESOP's?
The 50 percent
interest exclusion has been repealed for ESOP loans made after
August 20, 1996, so ESOP loans now cost more (but
requirements for the interest exclusion -- acquisition of 50
percent of the employer's stock and extended participant voting
rights -- no longer apply)
Starting in tax
years after 1997, ESOP's can be adopted by S Corporations, but
there will be reduced contribution limits and no Section 1042
Starting in tax
years after 1997, the Section 1042 rollover will be restricted
to purchase of securities in domestic operating companies that
are not S Corporations
must be the "best" class of voting stock and not
holding period for stock of selling shareholder
acquire at least 30 percent of employer's stock
Sale proceeds must
be reinvested in securities (stocks or bonds) of one or more
domestic operating companies (that's any U.S.-based company with no
more than 25 percent of its earnings from passive investments
excluding S Corporations after the 1997 tax year)
must be made no sooner than three months before and no more than
one year after ESOP sale
allocations cannot be made to selling shareholder, his family
members and 25 percent shareholders for a ten year period
ESOP must hold
acquired employer stock for three years
IRS filing of
written statements of employer and selling shareholder
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