How does an ESOP benefit your practice?
By Jason Charles
Preferred Benefit and Retirement Solutions
An employee stock ownership plan (ESOP) can serve as a tax-advantaged tool to help business owners exit their business all at once, or over time, while they are alive and healthy. It can maintain control of the process and help benefit their employees. For the producer, there are multiple life insurance and other asset sales opportunities available with ESOP companies. After you identify and prioritize your client’s needs, these plans can help you focus on offering solutions tailored to those needs.
How does an ESOP benefit your practice?
Whether a company already has one or is considering implementing one, an ESOP can present you with a variety of sales opportunities by asking your client the following questions.
• Exit planning – Will you be able to control the ownership transition of your company while you’re alive and healthy? Or will your business become part of your estate?
• Wealth transfer – How can you help minimize the impact of taxes and expenses while maximizing distributions to heirs, third parties or charities? Will your heirs be forced to sell your business in the event of your death?
• Income protection– If you became disabled, how would you protect your income for you and your family? Would you be able to cover your business overhead?
• Key person planning in the event of a death or disability– Losing a key person to a death or disability could temporarily, or permanently, affect your revenues and ultimately the value of your business. What steps have you taken to protect your business against the death or disability of one of your key employees?
• Key person planning while they are alive and healthy – How does your executive compensation package compare to your competitors? How would you feel if one of your trusted, key people left you and joined a competitor or started a competitive business? Have you considered offering additional benefits on a non-qualified-plan basis to selective key people to enhance their retirement benefits and incentivize them with cash or equity to remain working for your business?
• Retirement income – What percentage of your personal retirement is funded with your business? How will you convert your business equity into cash or retirement income? Will your retirement needs force you to sell your business?
• Liability financing– Have you conducted a study to forecast your future obligation to repurchase shares distributed from your ESOP? Have you made plans to ensure that you’ll have the liquidity to repurchase ESOP shares in the future and make good on your non-qualified plan future “promises to pay”? After prioritizing your client’s needs, you can help reduce their risk through the following funding solutions.
Corporate-owned life insurance to:
- finance non-qualified plan and ESOP repurchase liabilities.
- insure the lives of the owners and key people.
- enable the corporation to redeem shares from non-ESOP shareholder via buy-sell agreements.
- enable the company to provide life insurance benefits to the owners/key people.
- provide executives with an after-tax bonus plan to meet the needs of key people who may not qualify as members of the “top hat group,” or who prefer not to have their benefits at risk with the future non-qualified plan “promise to pay.”
- provide life insurance to fund a buy-sell agreement between two or more parties, such as an owner and key employee.
- The disability of an owner can affect the business in three key ways: 1.) A disability can impact the owner’s ability to meet personal financial obligations; 2.) It can put at risk their ability to meet current business obligations; and 3.) It could affect the ability of the business to survive.
- Disability insurance can help the insured meet personal financial commitments in the event of a disability. And, it can help a business owner meet business overhead expenses and provide loan protection during their disability.
- An ESOP is not an estate planning technique; however, it creates liquidity from privately held illiquid stock that can be repositioned using all of the traditional estate planning tools like ILITs, charitable trusts, family limited partnerships, LLCs, GRATs and all of the variations of annuity trusts in order to accomplish the business owner’s estate planning needs.
- An ESOP provides a business owner with a mechanism to convert the equity in the business into cash. The business owner will need expert advice to invest the cash proceeds from the ESOP sale.
- Internal Revenue Code (IRC) 1042 allows the shareholder of a C corporation to defer the capital gains taxes due upon the sale of their shares. However, the IRC includes requirements and restrictions that must be followed during the reinvestment phase in order to preserve the capital gains tax deferral. Well-informed financial advisors can help the business reinvest their proceeds and preserve the capital gains tax deferral.
- An ESOP is a qualified plan. Therefore, all of the same contribution and benefit payment limits that apply to other qualified plans apply to ESOPs, as well.
- When an owner or owners of a business sell stock to an ESOP and elect to defer their capital gains taxes, IRC 1042 prohibits certain individuals from participating in the ESOP (family members and any other shareholder who own 5 percent or more of the company, for example). A non-qualified plan can help replace these lost benefits for these individuals.
- An ESOP is a qualified plan and can be combined with 401(k) plans or other defined contribution plans.