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Area attorneys discuss the benefits of ESOPs

Legal News Reporter

Published: August 23, 2019

As more employers grapple with employee retention problems, many are looking to find methods and tools to attract top-notch workers and keep them engaged for the long haul.

Comprehensive health insurance plans, opportunities for promotion and generous contributions to employee retirement plans are some of the more common incentives offered to workers.

As Jazmyn Stover, a partner in the Cleveland office of the management-side labor and employment law firm Fisher Phillips, explains a number of larger businesses also rely on Employee Stock Ownership Plans (ESOPs).

“ESOPs can reduce voluntary employee turnover and increase overall productivity because employees have a vested interest in the company’s success since they own stock,” said Stover.

“These defined benefit plans are usually set up by the company’s financial institution and the specifics do vary among employers,” said Stover. “The number of shares that employees receive is directly dependent upon how long they remain with the business.

“When the employee retires, he or she can cash out the shares,” she said. “You may also have the right to transfer or distribute shares of company stock if you participate in an ESOP.”  

Although the first ESOP was established in 1957, the plans did not become popular until 1974 when their rules were outlined in the Employee Retirement Income Security Act (ERISA).

ESOPs must adhere to governmental regulations issued by the U.S. Department of Labor and the Internal Revenue Service. 

“ESOPs are generally provided by employers who have at least 50 to 100 employees,” she said. “They are usually not cost effective for smaller businesses or startups. However, it is something that startups should discuss with corporate counsel and their accountants right from the beginning so they can decide if this is an effective option for the business.”

According to the National Center for Employee Ownership, as of 2018, there were roughly 6,500 employee stock ownership plans in the U.S. covering more than 14 million participants.

While 401(k) plans and ESOPs both allow employees to defer paying taxes on their savings until after they retire, there are fundamental differences between the two.

“In the case of a 401(k) plan, the funds come directly from an employee’s check and the employer often contributes a certain percentage,” said Stover. “Essentially, the contributions placed in a 401(k) plan are used to invest in a variety of stocks, bonds, mutual interests and other investment, in which the employee is granted the right to withdraw from upon reaching the age of retirement.

“ESOPs are designed for employees to acquire an ownership interest in their employer’s company. Unlike 401(k) plans, ESOPs provide a retirement option for those employees who cannot afford to make regular payroll deductions to a retirement plan,” said Stover.

Denise Glinatsis Bayer, an associate in the Youngstown office of Harrington, Hoppe & Mitchell said ESOP stock is held in a trust outside the company, with a separate fiduciary obligation to act in the best interest of the participants in the ESOP.

“Each employee is the beneficial owner in the value of stock allocated to their account,” said Glinatsis Bayer. “Control of the ESOP is maintained by an outside trustee, however, employees get to vote on major decisions that affect the company.” 

In addition to employee retention, ESOPs also provide tax advantages to businesses.

Generally a percentage of the employer’s contributions to the ESOP is tax-deductible within certain limits, said Stover.  

“ESOPs are also the only qualified employee benefit plan that can borrow money,” said Glinatsis Bayer. “If a business does borrow money to expand, for example, it can deduct both the repayment and interest when it pays back the loan.”

In addition, Glinatsis Bayer said an ESOP can help owners to ensure that their companies survive even after they retire.

“As opposed to an outright sale, where owners may need to say goodbye to their business immediately, a transfer of ownership to a company’s employees allows owners to stay involved with their company as they receive payment for their interest—many times without the headache of a capital gains tax,” Glinatsis Bayer said.

“ESOPs are an increasingly attractive legal vehicle that can ensure that local, privately held successful businesses continue that success well after the initial owners of the business leave while providing a great incentive for an employee to stay with an employer for their entire career,” said Glinatsis Bayer.