Facts and Myths about ESOPs

Employee stock plans bank on bright future Financial strategy leads to success.

For half a century thousands of U.S. companies have enjoyed dramatic tax savings and cash advantages as sponsors of Employee stock ownership plans. How many?

While the federal stats lag by two to three years there currently are more than 12,000. While most ESOP sponsors are closely held private companies with from 25 to 150 employees, there are many large, high-profile public companies such as Peoples Supermarkets and Home Depot.

As reported earlier this year, Bernard Marcus, co-founder of Home Depot announced that Home Depot “created over 1,000 millionaires” in 1997.

– That’s right. Many of those people wearing the long orange aprons are (multi) millionaires.

Many business owners opt for selling some or all of their company to employees and by doing so convert corporate and personal taxes into tax-free capital appreciation for themselves.

The ESOP horizon remains very bright and Congress continues to broaden the qualification for ESOP sponsorship.

Effective this year, Subchapter S corporations also are qualified ESOP sponsors. This represents unique opportunities for S corp owners. As an example, many C corp owners sell their business to their ESOP and thereby avoid all capital gain taxes. Afterward, switching to an S corporation avoids all future corporate income taxes.

Why do more than 11,000 companies sponsor an ESOP? Because the ESOP is the most tax-advantaged mechanism for the owners of companies to achieve some very profitable goals.

First, you now have a willing buyer for some or all of your business and you pay no tax. Second, you can have the most cost-effective plan to motivate employees to give you their best efforts. After all, who works harder, owners or employees?

Suffice it to say that over the past 30 years, studies done by both federal agencies and the private sector conclude that, without question, ESOP companies are significantly more profitable than their counterparts.

An ESOP is an employee benefit plan operating through a trust that accepts tax deductible contributions from the company to purchase company stock. As mentioned earlier, the selling individual pays no tax. Think about how powerful an advantage this is to business owners. The business is purchased with tax-deductible dollars and the seller pays no tax.

The ESOP can acquire both new and existing stock. The ESOP trust can also borrow money.

Using an ESOP to borrow money is another dramatic cash advantage and tax savings opportunity for business owners because in paying back the loan both interest and principle are fully tax deductible.

Congress continues to endorse the tax savings and cash advantages available exclusively to ESOP companies. Now S corporations, as well as C corporations, are qualified sponsors.

Every day, business owners fight two battles. Making it and keeping it. The ESOP financial strategy helps win the first and virtually assures success with the second.

Myths & facts

The six most common misconceptions about ESOPs:

ESOP myths:

– ESOPs are a giveaway.

– Shareholders lose control.

– You must disclose financial data to employees.

– My employees can’t pay me what my company is really worth.

– ESOPs are for failing firms.

– ESOPs are forever.

ESOP facts:

– ESOPs buy company stock.

– Executives maintain complete control.

– Not required to disclose financial data, executive compensation or value of company.

– ESOP pays full market value.

– Ninety-eight percent of ESOPs are in healthy firms.

– ESOPs can be reversed.

– ESOPs can be reversed.

The Business Journal November 27, 2002

Frank Amato is Managing Membert of the Arizona ESOP Group, LLC http://www.arizonaesopgroup.com . He may be reached at (480)222-0199 or (480)227-3064.