Employee stock ownership plans (ESOPs) provide many tax advantages. An ESOP is a retirement plan under which a trust acquires the employers stock in trust for the employees. The ESOP trust will purchase the employers stock from the employer or the employers shareholder. The ESOP will acquire this stock by obtaining a bank loan. The bank loan is guaranteed by the employer. The employer will make yearly tax deductible cash contributions to the ESOP. The ESOP will use this cash to make payments on the loan. The ESOP will distribute shares of the employers stock to employees in accordance with the plans distribution requirements.

The ESOP is tax advantageous over other stock purchase mechanisms because the employees tax obligation is deferred until the employee sells the employers stock. The employee does not pay tax at the time of the employers cash contribution or when the stock is distribution from the ESOP plan. Yet the employer receives current deductions for the cash contributions to the plan or for stock contributed to the plan.

The main disadvantage of an ESOP is that an employer must comply with numerous ERISA requirements that are imposed upon retirement plans. These requirements relate to who must be covered, when are participants vested, how much is funded, reporting, disclosure, etc. Creation and maintenance of the plan can be expensive.

Also, adoption of an ESOP would mean that you must share ownership of your corporation. This raises the potential problems discussed above.

An ESOP does provide a market for your stock, however. If your goal is to sell your corporation, rather than to share ownership, utilizing an ESOP could be revisited. You could possibly obtain a significant cash payment for all of your stock. Of course, the payment (minus your basis in the stock) would be taxed at capital gains rate.

Before adopting an ESOP to purchase your entire interest, you should be consider a sale of the business to a third party. The after tax cash flow of both alternatives should be compared.