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ESOPs and S Corporations
By Jason Watson, CPA
Posted February 22, 2020
What happens when you have an S corporation but want to implement an ESOP? First, what the heck is an ESOP. According to a May 2017 article in the Journal of Accountancy–
ESOPs were created by the Employee Retirement Income Security Act of 1974 (ERISA), P.L. 93-406, and have long been used as a vehicle for ownership succession planning. According to The ESOP Association, there are approximately 10,000 ESOPs in the United States, covering 10.3 million employees. While ESOPs exist in a broad range of industries, they are most prevalent in manufacturing and construction companies, as well as engineering and architecture firms.
The basic gist is that the present owners sell their shares to the ESOP and typically take back a note from the ESOP (a loan). The ESOP can also obtain outside financing to purchase the outstanding shares. From there the business provides the funding to the ESOP to pay its debt obligation.
Of course there are stats everywhere suggesting that employee recruitment, retention and satisfaction all improve with an ESOP… but that can be costly too. According to the National Center for Employee Ownership (www.nceo.org) and affirmed by a Journal of Accountancy article, the cost to set up an ESOP which includes the feasibility analysis, paperwork and initial valuation ranges from $40,000 to $80,000 (and higher). As such this is requires some careful consideration.
However, succession planning is important in certain businesses. If you are a one-person engineering consultant perhaps succession is simply riding off into the sunset. Like Def Leppard sings, it is better to burn out than to fade away. But if you have a business that you would like to see carry on my wayward son while you fade away, like a smash up of Def Leppard and Kansas, then an ESOP might be the answer.
There is no need to regurgitate information that is readily available elsewhere. Please understand two things; first, ESOPs can provide some immediate tax benefits and second, S corporations have more limitations and annoyances than C corporations with respects to ESOPs. Here are some links-
wcginc.com/6113 (NCEO’s article on ESOPs and S Corporations)
wcginc.com/6111 (Journal of Accountancy on ESOPs in a CPA Firm)
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