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Leveraged ESOPs

Leveraged ESOPs

In a leveraged ESOP, the ESOP or its corporate sponsor (“the Company”) borrow money from a bank or other qualified lender. The Company will typically give the lender a guarantee that it will make contributions to the ESOP trust, which will enable the ESOP trust to payback the loans, or if the lender prefers, the Company may borrow directly from the lender and make a loan back to the ESOP.

If the leveraging is being used to provide new capital for the expansion or capital improvements, the Company will use the cash to repurchase new shares of stock in the Company. If the leveraging is being used to buy out the stock of a retiring owner, the ESOP will acquire those existing shares. ESOP financing can also be used to make acquisitions, buy back publicly traded stock, or for any other corporate purpose.

Three tax incentives make borrowing through an ESOP extremely attractive. First, since ESOP contributions made by the Company are tax deductible by a corporation, a corporation which repays an ESOP loan in effect gets to deduct principal as well as interest from taxes. Second, dividends paid on ESOP stock of a C-corporation passed through to employees, reinvested by employees for more Company stock, or used to repay the ESOP loan are tax deductible. Third, the most significant tax advantage of ESOPs is the ability of shareholders in a C-corporation, who sell shares to the ESOP, defer any gain from the sale if the sale qualifies as a tax-free rollover under Section 1042 of the Internal Revenue Code. This benefit is available whether or not the ESOP is a leveraged ESOP.

The rules for implementing and maintaining an ESOP are complex. Plan sponsors interested in instituting an ESOP for their company would be well advised to contact qualified legal counsel and other qualified professionals as needed for this initiative.

NEED MORE INFORMATION?

If you need more information regarding this or any other topic affecting your retirement plan, visit our Withum ERISA Knowledge Corner online, follow us on Twitter at WSB_ERISA or contact us at [email protected] to arrange a free consultation today.

The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your plan’s individual facts and circumstances.

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