ESOP’s Role in Estate Planning

Many owners of closely held businesses realize Employee Stock Ownership Plans (ESOPs) effectively meet their liquidity and business succession needs. Through this process, they discover that ESOPs also have tremendous value as an estate planning tool, an often overlooked benefit. The benefits come in the form of reduction of estate taxes, gifting plans, accurate valuation and liquidity options.

Tax Advantages

In an ESOP transaction, the shareholder always has the opportunity to sell stock, as opposed to selling to a third-party buyer who would likely want to buy assets. The practical result is that the selling shareholder will be paying capital gains taxes on the proceeds rather than a blended rate of capital gains and ordinary income tax representing average savings of more than 10%. In many situations, the shareholder may defer all taxes in the sale to the ESOP, according to section 1042 of the Internal Revenue Code. Section 1042 allows the selling shareholder to transfer the basis in their closely held company to qualified replacement property (U.S. stocks and bonds), allowing them to defer any tax on the sales proceeds and, often, avoid it all together. If the shareholder passes the qualified replacement property through to their estate, their heirs will inherit these securities at a stepped-up basis and the tax from the sale of the company to the ESOP will be avoided all together.


For an immediate planning tool, the sale to an ESOP presents an advantageous way to institute a gifting plan. A large number of closely held businesses are capitalized mostly by equity and carry very little long term debt on their books. This characteristic makes these companies attractive candidates for using ESOPs as a liquidity option. Typically, the sale of company stock to an ESOP involves the company taking on additional leverage to finance the transaction. Whether this leverage is provided by a bank or the selling shareholder, the company’s post-transaction balance sheet usually displays a significantly different capital structure than it did pre-transaction. The additional debt depresses the equity value of the company, making it an excellent tool to gift shares to future generations.Due to federal limitations on the amount of value that an individual can gift tax-free to future generations, business owners are often gifting minority stakes of their closely held business to their heirs on an annual basis. The value of the gift can be further depressed through the use of discounts, which are applied to minority positions. Applying reasonable assumptions of the amount of debt a company would incur as part of an ESOP transaction as well as the discounts that should be applied to a minority stake, allow the shareholder to make gifts at a value that is substantially below the initial, pre-ESOP, market value of the stock.

Flexible Planning

With a seller financed component to an ESOP transaction there are numerous tools with which to plan estates: cash, notes, stock and often warrants. This provides maximum flexibility in estate planning. If a gifting program is not a strategy of interest to a business owner, an ESOP transaction provides other benefits from an estate planning standpoint. One of the requirements that the Department of Labor has for companies owned by an ESOP is that they undergo an annual appraisal to determine the market value of the company. The established equity price makes it far less likely that the Internal Revenue Service will attempt to have its own independent appraiser assign a value to the shareholder’s company, which can lead to unforeseen estate taxes. The established ESOP also serves as a ready buyer for the stock of the shareholder. This prevents the situation where the surviving spouse or other heirs are forced to sell the business at a distressed price. ESOPs provide numerous estate planning opportunities during various stages. While ESOP transactions are becoming a more widely known liquidity strategy for business owners, the ancillary benefits are significant and often overlooked.

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Will Stewart

Investment Banking | ESOP
Orlando Office

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