Academic journal article Journal of Accountancy

The ESOP Exit Strategy: Explore the Advantages of This Popular Tool for Succession Planning

Academic journal article Journal of Accountancy

The ESOP Exit Strategy: Explore the Advantages of This Popular Tool for Succession Planning

Article excerpt


* S corporation tax attributes make ESOPs very attractive. More companies installing ESOPs are arriving at an employee-owned company often with 100% of the stock.

* S corporation and C corporation attributes (including the IRC [section] 1042 tax-free rollover) may be combined to forge a flexible succession plan meeting the goals of sellers, senior management and ESOP participants.

* The potential for future tax increases magnifies the tax incentives enjoyed by ESOPs.

* An aging population increases the demand for succession alternatives, including ESOPs.

* Optimal financial results are obtained when the ESOP is combined with ongoing communications to educate employees about the responsibilities and obligations of ownership.

* ESOPs are practical for both business owners and CPA firms.



The scenario is all too common. A majority partner wants to retire, but the remaining partners can t afford to buy him or her out, or they want out themselves. Key employees eye the door as rumors swirl that the company may be sold to a larger competitor that is sure to clean out any "redundancies." And other interested parties--key customers, suppliers and lenders begin to ask about the owners' succession plan.

The confluence of 35 years of progressive employee stock ownership plan (ESOP) financial successes, S corporation tax attributes, potentially higher taxes on the horizon and an aging baby-boomer generation combine to make ESOPs an attractive option that private company CFOs--and the CPAs who advise them should consider.

This article examines why ESOPs are more appealing to both selling shareholders and ESOP participants now than in years past, defines issues that must be fully considered before installing an ESOP, and highlights common attributes of successful installations.


Employee Stock Ownership Plans and Trusts (ESOP) became available under the Employee Retirement Income Security Act of 1974 (ERISA) as qualified retirement plans. In the intervening years ESOPs have evolved into a powerful and comprehensive exit planning option for many business owners.

An ESOP is a tax-qualified defined contribution employee benefit program intended to primarily invest in the stock of the plan sponsor company. Significantly, the ESOP is primarily invested in employer stock; it's generally understood that more than half the plan assets are employer stock. The ESOP owns the stock for the beneficial interests of the employees, with the stock allocated to the accounts of the employees and not other legal entities such as a partnership or LLC. More significantly, at the higher employee ownership percentages, the ESOP is the controlling shareholder.

From the earliest days until 1996 the number of C corporation ESOP installations grew steadily. Such installations enjoyed certain tax advantages but were still subject to C corporation income taxes and had the repurchase obligation, which requires the sponsoring company to make a market for the stock allocated to the ESOP accounts of departing employees. Together these formed an onerous financial obligation. But following a legislative change in 1996 that opened ESOPs to S corporations, it is now estimated that 70% to 80% of ESOP installations since then have been in S corporations. Exhibit 1 indicates the growth in ESOPs and other equivalent plans as estimated by the National Center for Employee Ownership (NCEO) after eliminating sham plans from the early 2000s.


Theoretically, business owners enjoy a wide range of exit options. These include sale to a strategic buyer (often a competitor or other player in the same market or industry) who sees synergies with existing business interests; sale to investors such as private equity firms and wealthy individuals; or an initial public offering (IPO). …

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