Sounds too good to be true, right? While this strategy won’t work for every small business owner, for those who are able to implement it properly, an ESOP (Employee Stock Ownership Plan) can provide staggering tax benefits and a smooth exit strategy for business owners. Let’s check it out. 

What is an ESOP? 

An Employee Stock Ownership Plan, or ESOP, is a less traditional way for business owners to sell a business. Under an ESOP, a separate legal trust is created and the trust must purchase shares of stock from the business. Employees who choose to participate receive stock in the trust, creating an employee owned business. Business owners can exit the business slowly or all at once by selling off stock to the ESOP trust.   

Why Would I Choose an ESOP as an Exit Strategy? 

When it comes to your business, there are many benefits and trade offs to any exit strategy. An ESOP creates an ownership structure that encourages employees to stay longer with the company, become creative and find solutions in difficult situations, and generally act in the best interest of the company. After all, they are all owners of the business. 

Another primary benefit of the ESOP exit strategy is the tax benefits. When you sell a minimum of 30 percent of your business to a properly organized ESOP trust, you do not have to immediately pay capital gains taxes on that sale. There are some strict stipulations on this, however, but the benefits are staggering. If you sell your business to an ESOP, the money you would have paid in taxes must instead be used to purchase a qualified investment. This is not a way of not reporting your taxes, but is a legal way to defer the payment of those taxes until the time that you cash out the qualified investment. 

Here is where it gets really interesting: If you choose never to cash out the investment in your lifetime, after your passing your heirs will receive a step up in basis on that investment. This virtually eliminates the tax implications of selling your business. 

Here’s an Example: 

Say you sell your business to an ESOP for $5 million. The taxes would likely be at least $1.25 million dollars. If that money is properly invested instead, you will not pay any taxes on it until you sell that investments. If you live another 20 years without touching the money, doubling your investment every decade, your investment grows back up to $5 million. 

When you pass away, this investment would transfer to your beneficiaries tax free. That is almost like selling your business twice. The first time, you benefit directly from all but the amount that would have been taxed anyway. After your passing, your heirs receive an additional $5 million. Not too shabby. 

Contact Qualified Professionals Today 

An ESOP is a great tax strategy, however it is not a program that can be set up on your own. You will need to be careful how you implement this strategy to receive the tax benefits. There are many rules and regulations surrounding this business exit strategy. 

You will likely need to involve a qualified tax professional to make sure the sale of the business is properly reported, a lawyer to set up a legal ESOP trust, an investment firm to insure the money is all transferred into a qualified investment, a human resources professional or firm to make sure your ESOP is operating in compliance with all federal requirements, and a trusted financial institution to finance the ESOP’s purchase of your business shares.  

To listen to our full podcast about ESOPs, click here.