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Insights
Accounting
Creating a win-win
How employee stock ownership plans provide business owners a competitive advantage and tax savings
M
ost business owners don’t start a company thinking about the day they’ll retire and leave the company in someone else’s hands. The business they founded
is a large part of their identity and their life.
But when they’re ready to retire or reduce
their role in the company and welcome new
ownership and leadership, it’s a relief to know
they’ve left their enterprise in good hands. An
excellent way to do that is with an ESOP, an
employee stock ownership plan.
An ESOP isn’t just an ideal vehicle to transition ownership and boost the founder’s liquidity; it’s also a superb opportunity for business
owners to save on federal income taxes while
encouraging employee productivity.
Creating and administering an ESOP is a
smart move for many forward-thinking business owners, says Bill Norwalk, a tax partner
at Sensiba San Filippo, a CPA and business
consulting firm with four offices in the San
Francisco Bay Area. He has nearly 30 years
of expertise advising company owners on
ESOPs and tax-related matters.
Smart Business recently asked Norwalk
about vital details of ESOPs that savvy business owners should know.
What is an ESOP and which businesses
should consider one?
Simply put, it is an employee retirement
plan. It’s a tax-exempt trust that gives workers shares in the company that employs them.
Key factors for a company considering an
ESOP are profitability and size. A business
needs at least 25 employees and should have
an independently appraised value of at least
$4 million to make it worth the cost and effort
to set up an employee stock ownership plan.
There needs to be a significant payroll — I
advise at least $1 million — because payroll
generates the contribution to the retirement
plan that provides funding for the stock sale.
ESOPs are especially beneficial for owners
interested in liquidity with a solid history of
earnings and the ability to attain financing.
The company also needs a capable management team with a clear vision and succession
plan for when the owner/stockholder is ready
to sell his or her shares and leave the business. The owner’s day-to-day activities as an
employee also need to be transitioned prior
to his or her departure.
Bill Norwalk
Tax partner
Sensiba San Filippo
ployer stock with about 13.7 million participants, according to the National Center for
Employee Ownership. The value of those assets is an impressive $923 billion. Small businesses are most likely to create ESOPs; 72
percent of the ESOP Association members, a
national non-profit membership organization,
have less than 250 employees.
But I’ve helped companies of all sizes create ESOPs. One of my clients is a profitable
business, which has a stock value of approximately $6 million. After years of hard work,
he wanted to retire but remain involved in the
business on a limited basis. He agreed to sell
30 percent of his shares to the business. He
was able to defer the gain on the significant
amount of cash he received because he reinvested the funds into qualified replacement
securities, which is stock or long-term debt
in U.S. companies. So he gets a steady return
from a diversified portfolio, and he has reduced his day-to-day involvement in the business’s daily activities.
His company benefited too. It saved significant income taxes because of the money
it contributed to the plan. The value of the
shares owned by the plan increased, benefiting the employees, who will, over time, vest
in those shares.
How does an ESOP aid a business owner?
How popular are ESOPs?
An ESOP can help owners in several ways.
There are about 11,400 ESOPs and other
profit-sharing plans invested mostly in em-
It provides liquidity while they continue to
work in the business overseeing the company’s transition to new ownership. The
ESOP provides reliable cash flow for a retired
owner, who’s been able to sell the business
without paying federal income taxes on the
sale. The owner benefits from being able to
replace company stock with securities that
yield cash, deduct interest and principal on
loan repayment and ultimately create a company that pays no federal income taxes. That’s
a significant advantage in any marketplace.
A business owner often leaves profits in the
business to help it grow. The value tied up in
the business is often the owner’s largest asset.
Founders feel a sense of personal responsibility to the employees who helped build the
business, and they want to see the business
flourish long after they leave. At some point,
they are ready to reduce their involvement in
the business, retire, or preserve value outside
of the business for their heirs. In the right circumstances, an ESOP can help achieve each
of these goals.
What are some advantages of an ESOP for
employees?
It’s free money. In fact, retiring employees
can end up with more value allocated to
them by the company through an ESOP than
through a 401(k). A company can even offer
a 401(k), in addition to the ESOP, in certain
circumstances.
We serve a 100 percent ESOP-owned
company that pays no federal income taxes
because it is taxed as an S corporation. Because the income is allocated to the nontaxable trust that owns the shares, it is exempt
from paying federal income tax. A portion of
the tax savings leads to higher compensation
for employees and a larger amount of profits
available to distribute to the trust, which enhances the value of each eligible employee’s
retirement.
Do you have any final words of advice?
An ESOP can be a tremendous opportunity and one that I recommend to clients for
tax savings and as part of a succession plan.
However, it’s not right for every business.
Working with an accountant who is a trusted
adviser who knows a business owner’s longterm goals, both for the business and personal retirement, is crucial to evaluating this
opportunity. <<
BILL NORWALK is a tax partner at Sensiba San Filippo LLP. Reach him at (925) 271-8700 or [email protected].
Insights Accounting is brought to you by Sensiba San Filippo
© 2012 Smart Business Network Inc. Reprinted from the January 2012 issue of Smart Business Northern California.