One theme I regularly explore on this blog is the need for small-business owners to have a succession plan. One of my earliest posts on the subject explored three options for how an owner could deal with a small business in his or her estate plan: (1) pass it on to his or her children; (2) sell it to a business partner; or (3) sell it to a third party.
Unsurprisingly, that post just scratched the surface. Today, I want to discuss another option for small-business owners that recently got a boost from Congress: transferring the business to employees under an employee stock ownership plan (ESOP).
What is an ESOP, how does it work, and what are its benefits? Keep reading to find out!
Employee Stock Ownership Plans: What Are They?
Employee stock ownership plans are a type of tax-favored employee benefit plan. With an ESOP, a business creates a trust to hold shares in the business, and allocates shares in the trust to its employees. When an employee retires, he or she can keep those shares or sell them.
ESOPs offer several benefits to employers and employees. For example:
- Tax-deductible contributions. Contributions of shares (or cash to buy shares) are tax-deductible for the business, subject to some limits.
- Tax deferral for employees. Normally, employees pay income and payroll taxes when they receive compensation from their employer. But employees do not have to pay income tax on their shares in an ESOP until distribution, meaning they can push back that tax to retirement.
- A stake in the company. Through an ESOP, employees are given a stake in the company, which encourages them to think more about the business’ long-term success, not just the next paycheck.
And, most relevant for our purposes, an ESOP gives small-business owners a way to transfer their interest in the business to the employees who know it best. Doing so could help the owner avoid the need to find a third-party buyer or entrust the business to a relative who may not understand it as well.
Recent Changes Benefiting ESOPs: Simpler SBA Loans for ESOPs
In August, President Trump signed the John S. McCain National Defense Authorization Act into law. That Act, which was mostly concerned with military spending, included a provision meant to help make it easier for ESOPs to obtain financing for further stock purchases. As CNN explained:
[The Act] directs the Small Business Administration [SBA] to make its loan guarantee programs more readily available to employee stock ownership plans . . ., which often have trouble accessing capital through regular banks. It also makes it easier for a business to transition to worker ownership.
Naturally, the details of the changes are complicated—as are most things involving the SBA. But these changes may mean that you now have one more option for dealing with your business in your estate plan.
Is an ESOP Right for Your Business?
Of course, just because ESOPs are an option for transferring your business doesn’t necessarily meant that they are the right one. After all, setting up an ESOP is a highly technical—not to mention expensive—exercise. To determine what option is right for you, you need to consult a knowledgeable estate-planning lawyer and tax professionals.
If you’re a small business owner who is interested in exploring what succession options are available for your business, contact me to set up an appointment so we can begin that process.