- When employees have interest in a company, performance and productivity may improve. Employees recognize more clearly how their success impacts the company’s value and, consequently, their shares. Increased individual commitment can also cultivate a strong internal culture.
- Retention might receive a boost because employees want to maintain growing shares and/or they enjoy seeing their work rewarded so tangibly. An NCEO study found that among employees aged 28 to 34, those with ESOPs had a 53 percent longer median job tenure than those without any form of employee ownership.
- For companies structured as S corporations (pass-through entities with ownership limitations), the percentage owned by the ESOP is exempted from federal and most state income taxes. C corporations (entities that pay corporate income tax and have no ownership restrictions) may deduct contributions used to make principal payments on an ESOP loan, which is used to purchase company shares for the plan.
- Employees pay no taxes on their shares until they receive distributions (which can be rolled into an IRA or new retirement plan to further defer taxes).
How an ESOP Works
ESOPs are organized as a trust that companies sell their existing or newly created stock shares to, financing them through specialized loans or purchasing them with cash. A trustee (either a person or committee) administers the plan, and employees who participate in the ESOP are given a specific number of shares and may be eligible for more the longer they are with the company.
Typically, it is only at the end of employment that shares are sold back to the ESOP and employees are compensated for them (ESOPs are the legal owner of the shares, so employees cannot sell at will). Distributions are subject to income tax, but there may be an excise tax for those who receive their distribution upon leaving the company early or termination. Some plans distribute regular dividends to employees, as well. Distributions can be rolled over into an IRA or another tax-qualified retirement plan to further defer taxes.
How to Start an ESOP
Before establishing an ESOP, interested companies should conduct a feasibility study to ensure the business can sustain one and that there is sufficient interest from employees who would be participating in the plan. If so, an attorney with experience in ESOPs can draft the documents in concert with company leaders, outlining the plan’s structure and guidelines. Next is connecting with a commercial lender familiar with financing ESOPs and identifying a trustee(s).
Once up and running, an ESOP may foster an extra sense of pride and commitment that provides an advantage in the market, eases any retention concerns and unlocks a new level of success.
For more information on starting an ESOP and retirement plans, consider a chat with the experts at F.N.B. Wealth Management.