An ESOP is a type of pension plan which is designed to invest primarily in the stock of the employer corporation. It is the only type of pension plan which can borrow money. Congress has created numerous tax incentives for corporations to promote the formation of ESOPs, including:
- The ability of the selling shareholder not to recognize gain on the sale of stock to the ESOP, assuming certain requirements are met
- The ability of the corporation to deduct contributions made to the ESOP to pay both interest and principal on loans made to an ESOP
- The ability of a corporation to deduct dividends paid on stock held by an ESOP
- ESOPs holding stock of an S corporation are not to be subject to tax on their share of corporate earnings
Due to these and other tax incentives, and when used in conjunction with various recapitalization and financing strategies, ESOPs offer business owners an attractive alternative, on an after-tax basis, to sale of the business to a third party.