The Tax-Saving Tool You're Not Using
In his latest book, Money: Master the Game, Tony Robbins reminds business owners to maximize the tax-deferral advantages of common tools like 401Ks and Roth IRAs. But the business and life strategist also recommends a less talked-about tax-benefit tool: ESOPs.
Employers establish ESOPs (employee stock ownership plans) to offer their workers a portion of company ownership through stock. Companies invest up to 25 percent of the value of total payroll into this tax-exempt trust for all participating employees. Unlike a 401k, cash contributions are funded by the employer, not staff salary deferrals.
The ESOP operates much like a shareholder in the company, the value of which is allocated among employees as it hopefully grows over time. That sense of ownership can even increase engagement. In the latest annual ESOP Association survey, 76 percent of members cited their ESOP in boosting productivity.
But ESOPs can bring much more than morale. For S-status corporations with 100 percent of stock invested in an ESOP, the trust is exempt from taxes at the federal level meaning up to 35 percent of a company’s revenue could be sheltered from income tax altogether. If a C corporation meets certain requirements, the company owners can sell their stock to the plan on a tax-deferred or, in some cases, tax-exempt basis.
“The tax deferral opportunity can be extremely powerful in certain situations,” says Bruce Ashton, a Los Angeles-based attorney at Drinker Biddle’s Employee Benefits & Executive Compensation Group. Adds Robbins, “ESOPs could change the tax basis of your company massively.”
Owners about to retire might take special interest in these plans. ESOPs allow owners to “slowly extricate themselves from the company,” says Mark Kohler of Kyler Kohler Ostermiller & Sorensen, a nationwide law firm that focuses on tax, retirement, and strategic business planning. The plans help entrepreneurs control the pace at which they relinquish their management role and allow them to structure their income needs for post-retirement. That might be especially beneficial in difficult situations where one partner has an illness and wants to both guarantee his family an income stream while still handing over ownership of the business.
While there are no requirements for company size, Ashton notes candidates must be profitable enough to handle the related administrative and legal fees since those are the employer’s -- not the investment plan’s -- responsibility. According to the National Center of Employee Ownership (NCEO) this set up alone could cost around $40,000 for some companies.
Those wondering if their company could benefit from this "rare" tax-saving tool should work with their lawyer or accountant. Do a tax-benefit analysis, advises Kohler. “Make sure the costs are worth it.”
Related Book: The Tax and Legal Playbook