Tax Benefits of Employee Stock Ownership Plans

As an entrepreneur, an employee stock ownership plan can be an appealing way to give your employees an ownership stake in the business via stocks. This investment vehicle empowers your workers to invest tax-free money directly in your company and cash out their funds when they reach retirement age. But the benefits of an ESOP go beyond perks for your crew — investing in your own employee stock ownership plan comes with its own tax benefits. Here’s a look at how investing in your ESOP can benefit you.

Take advantage of these deductions

Planning for succession

Every small business owner has to consider the future of the company — and that includes coming up with a way to hand the reins over to a successor. An ESOP can enable you to transfer ownership of your company without losing a large chunk of that wealth to taxes, explains Lambert. If your business is a C-corporation, and you sell 30% or more of your ownership stake to the ESOP, you may defer or completely bypass capital gains taxes. In order to receive this tax benefit, you’ll need to reinvest the money into the bonds or stocks of other operating companies in the United States. Mutual funds and government bonds aren’t eligible, according to Lambert.

Potential drawbacks

While ESOPs offer entrepreneurs a variety of benefits, they carry certain drawbacks, like all financial decisions. Lambert explains that ESOPs only apply to S- and C-corporations, and are not applicable to partnerships or other business structures. Second, you can run into trouble if many employees simultaneously quit or retire, since ESOPs are obligated to buy back their shares in the company. Third, as you issue more shares to your growing business, each share will represent a proportionally smaller stake in the company. And finally, Lambert reports that ESOPs can be quite costly to establish, with the most basic plans starting at around $40,000.

If investing in your own ESOP is the right move for your needs, you could reap benefits for years to come. Before establishing or modifying an employee stock ownership plan, consider the counsel of your company’s leadership and the advice of a financial advisor.