Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

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How does selling to an ESOP compare to selling to an Employee Ownership Trust?

The main differences are that sales to an ESOP can provide substantial tax benefits to the seller, the company, and the employees. These tax benefits come with a variety of rules and compliance issues making ESOPs more complicated to set up and manage. Sales to an employee ownership trust include no tax advantages but also no specific set of rules or compliance requirements.

In an ESOP, the seller can defer capital gains tax on the sale to the ESOP if the company is or becomes a C corporation and the ESOP ends up with at least 30% of the shares. The funds used to pay off the loan (principal and interest) used to acquire the company or any cash contributions made to the plan to buy shares are tax deductible. Employees pay no tax on allocations to the ESOP while still employed, and when they leave they can roll their distribution into an IRA and defer tax until later. S corporation ESOPs pay no tax on profits attributable to the ESOP; 100% ESOPs pay no income tax.

In return for these benefits, companies must include at least all full time employees in the plan after one year of service. Employees have accounts in the ESOP and receive an allocation of benefits based on their relative pay or a more equal formula. Account balances vest over not more than six years. Employees have very minimal required voting rights. The shares are held in a trust overseen by a trustee. All share purchases must be based on an independent third party valuation.

In an employee ownership trust, sellers would pay capital gains tax on the sale. Funds used for the acquisition would not be tax deductible. Employees do not have an actual equity interest in the company through a trust as they do in an ESOP. Instead, employees receive a profit share or dividends, both of which are taxable as ordinary income. The company pays taxes like any other company. The company can set whatever governance rules it chooses. Because of these differences, employee ownership trusts typically cost about one-fourth or less of the cost required to set up an ESOP.

For more details, see Using an Employee Ownership Trust for Business Transition and Selling to an ESOP and Financing the Deal.

Link to this FAQ Topic: Employee Ownership Trusts (EOTs)