No fable: ESOP a great incentive for employees

By Stephen G. Smith

For the Journal-Constitution

Sunday, March 01, 2009

What
is an ESOP? No, it’s not a fable, that was Aesop. The acronym stands
for Employee Stock Ownership Plan. But, during this financial downturn,
you might want to think of it as an Economic Stimulus Offering
Possibility —- the possibility to inspire employee loyalty and provide
liquidity for your company (or you), all while enjoying significant tax
breaks.

An ESOP is a tax-qualified retirement plan designed to borrow money
and use the proceeds to buy stock of the sponsoring employer on a
tax-advantaged basis. In other words, it enables employees to own stock
in their employer. Unlike other qualified retirement plans, like a
401(k), an ESOP is required to invest primarily in the sponsoring
company’s stock.

While the Southeast has not seen a proliferation of ESOPs, it has
its fair share. Such plans have been quite popular in other parts of
the country for some time because of their powerful tax advantages.

For example, a shareholder who sells his or her stock in a privately
held company may defer all of the taxable gain on the sale, provided he
or she reinvests the sales proceeds in “qualified replacement
property.” That basically means debt or equity securities of any U.S.
operating company.

The use of an ESOP may allow a corporation to deduct dividends paid
to the ESOP. An ESOP can also be used as a tool of corporate finance,
allowing the corporation to deduct debt service on corporate borrowings.

Recently, ESOPs received a major boost through the change in the
Internal Revenue Code allowing ESOPs to be a shareholder of an S
corporation. Basically, all of the income of the corporation that is
allocated to the ESOP, as an S corporation shareholder, is not taxed —-
a powerful economic advantage. If the ESOP owns 100 percent of the
stock of an S corporation, none of the income of the corporation is
taxed. The tax savings can be used to pay the debt incurred by the ESOP
to buy the stock.

ESOPs can be an effective weapon for combating the economic crisis.
In fact, ESOPs are one of the few ways to raise capital during a
recession. They also shield you from the volatility of the markets by
keeping your company private.

Family-owned businesses, especially companies owned by baby boomers
who want to “get liquid” as they approach retirement, are good
candidates for ESOPs. They offer an alternative to selling the company
outright to a third party; owners can still “sell” their business and
gain much needed cash while staying in place —- often a preferred route
to an orderly succession.

ESOPs also keep companies local rather than selling out to national
or international entities. Indiana recently incentivized, through a
“linked-deposit” program, the establishment of ESOPs as a means of
boosting the local economy. State Treasurer Richard Mourdock explains,
“ESOPs have a clear track record of creating wealth, encouraging
entrepreneurial attitudes, and increasing productivity.”

Because ESOPs are advantageous financing tools, they can be used in
almost any industry. This includes highly regulated fields like
financial institutions, insurance companies, accounting and health care
firms. ESOPs are flexible; they can be structured a variety of ways to
achieve the owner’s goals.

When they are formed, ESOPs often encourage the company to award
equity to key management employees in exchange for a commitment to
remain with the company and achieve reasonable financial performance
over the long term. Thus, for little or no cash outlay, and without
affecting the price paid to selling shareholder(s) for their stock, key

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