As a small business owner, you value your employees. Giving them a slice of the company pie via an employee stock ownership plan (ESOP) is a great way to reward hard work and have a plan for your business’s future. It can also benefit you a bit, too!
This is just one of many options to transfer business ownership, so how do you know if the benefits are best for your business?
At CSI Accounting & Payroll, we’ve worked with small business finances for over 50 years. That means we’ve gotten a lot of questions about using ESOPs to transfer business ownership, including:
- What is an ESOP? What are the benefits?
- What do I need to know about rollovers and cashing out? What about tax considerations?
- Does the IRS target ESOPs? Why?
Benefits of an ESOP
An employee stock ownership plan (ESOP) is a special kind of tax-advantaged trust. You sell your business to the ESOP, and it allows you to get fair market value without having to search for a buyer.
It lets any of your employees obtain a portion of ownership that’s vested over time, much like profit sharing is. In a sense, it’s a reward for longevity with the business.
Since it makes your employees owners, it can also motivate them to make decisions that make the company as profitable as possible. The ESOP can grow to be a major part of their retirement savings.
If you sell all of your shares to the ESOP, you get capital gains tax rates. That’s a good deal!
Otherwise, you don’t have to fully sell the company. You can still be a partial owner for as long as you like. By maintaining some shares, you can take advantage of the same benefits that your employees do. Let’s talk more about those benefits in the next section.
ESOP Rollovers, Cashouts, & Taxes
An ESOP is very similar to a retirement plan. The money grows in the account, and it’s tax-deferred. It’s also treated nearly the same for rollovers, cashouts, and taxes.
ESOP Rollovers
Just like with any retirement plan, your employees can roll over their funds to a different retirement account if they move to a different business.
As the owner, it’s not likely that you would want to do this. (Although you can if you no longer want to control the business.)
ESOP Cashouts
Then, the employees can cash it out at retirement or earlier (sometimes with penalties – rules vary by ESOP). This process is the same for you, too!
This is also done the same as a retirement plan. You check your eligibility and request a distribution from your plan’s administrator. Depending on your ESOP, you may be able to get a lump sum payment or installments over time.
ESOP Taxes
If your employees leave your company and roll over their ESOP funds to a different retirement plan, they may be able to defer paying their taxes until they cash out.
Under most ESOPs, when you cash out, you’ll need to pay ordinary income tax. You may also face an early withdrawal fee if you don’t meet cashout requirements yet.
IRS Targeting ESOPs
There’s a rumor that the IRS targets ESOPs. This is only partially true; the IRS looks closely at any tax-advantaged plan since there’s a potential for abuse.
The IRS will make sure you’re using the ESOP correctly and following tax laws, even if it can be complex and expensive to maintain.
To stay in good standing, make sure that you:
- Do a cost evaluation every year.
- Have a board of trustees.
- Follow your ESOP’s rollover, cashout, and tax rules closely.
Worried about staying in compliance? Here’s how!
Plan Your Business’s Ideal Future With Monthly Accounting
Now that you know about the benefits of ESOPs, how rollovers, cashing out, and taxes work, and why the IRS takes a closer look at ESOPs, are you ready to check out monthly accounting services?
If so, please consider CSI Accounting & Payroll! While we don’t work directly with ESOPs, we can get your finances in tip-top shape and either look at other business ownership transfer methods or refer you to an ESOP specialist.
To see if we can be a good fit for your business, click the button below for a free consultation:
Not ready to talk? That’s okay! First, learn more about how an accountant can set up your business for future success.
