The Time-honored ESOP
Employee stock ownership plans (ESOPs) continue to be a simple way to transfer ownership of private companies. They offer great tax advantages both to companies that use them and to banks that help finance them. When those breaks are combined with benefits from insurance policies, much of the cost of ESOP transactions can be offset.
Here's how the strategy works. The company owner sets up an ESOP in much the same way any benefits plan is established. Then the ESOP obtains bank financing to pay for the company stock the owner plans to sell to it. "Banks pay tax on only a portion of the interest paid to them by ESOPs, so they have an incentive to make these loans," says Richard Snipes, a benefits and insurance consultant at Barry, Evans, Josephs & Snipes Inc., in Charlotte, N.C.
The company, not its employees, then pays off the ESOP loan out of cash flow, by making contributions to the ESOP. That way, both the principal and the interest are tax deductible.
"The owner gets to sell off his stock at whatever annual pace appeals to him. There's no cost to the employees, who eventually get to take over the company. And for the company, the cost of the buyout is fully deductible," says Snipes.
There's only one big expense: the cost of buying out each employee, as is required by the IRS, upon the employee's departure. Normally, that's a burden the corporation has to bear, but Snipes suggests using company-owned life-insurance policies to provide the cash necessary when ESOP buyouts come due. "Companies can design policies so they will be financially cushioned, either through death benefits or by bor-rowing against the cash value that has accumulated in policies." -- Jill Andresky Fraser* * *
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