So let’s get to some basic information. More than 30 years ago ESOPs were conceived by a San Francisco attorney with the intent of providing a basis for employee participation in the ownership of American businesses. In addition to being a morale booster, ESOPs have, as you will learn, become a most magnificent financing tool. They have received on-going support from members of Congress because they add to employees' limited benefits from Social Security.

To qualify, a business should be a “C” corporation. (If it is an “S”, then it should be converted to a “C.”) Additionally, the selling shareholder(s) must have owned their shares at least three years. The business can be a corporation, which is formed in order to qualify for an ESOP, so long as the shareholder has operated the business for at least three years.

A trust is formed (the Employee Stock Ownership Trust) and, to qualify for the significant tax benefits, the Trust must purchase at least 30% of the outstanding shares. The client can defer all capital gains tax if, within three months prior to or within 12 months after the sale of the shares, the selling shareholder buys and holds domestic securities with the proceeds of the sale of his stock to the Trust.

Since the shares owned by the ESOP Trust accrue to the benefit of the participating employees at no cost to them, no employee agreement or employee contributions are necessary. The Corporation's board selects the Trustee, who in turn votes the shares of the Trust; therefore no control of the company is lost and the employees do not “run the business”. However, if the Trust buys 100% of the shares, the employee participants elect their own board and officers.

Management determines the employee requirements for participation, such as length of service, etc. There is an advantage in having as many participants as possible since contributions by the corporation to the Trust are made based on the total payroll of the plan participants. Union employees can be excluded since they usually have a separate plan as part of their bargaining process.

There is another welcome tax advantage. The corporation makes annual contributions to the Trust in an amount of no more than 25% of the annual payroll of the plan participants, and that contribution is fully tax deductible. The Trust, in turn, uses these contributions to make the loan repayments using the tax-deductible dollars rather than “after tax dollars dollars. In addition, tax-deductible dividends can be paid to the ESOP to increase the amount of funds available for the ESOP’s purchase of shares.

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