Smart Succession: Using ESOPs to Preserve Wealth and Transition Ownership
Posted by Cheryl A. Jankowski on June 12, 2025
For owners of closely held businesses, a substantial part of their personal wealth is typically associated with the business. Preserving and transferring that wealth efficiently—especially during a business exit—requires strategic planning. One powerful tool that can serve both business succession and estate planning goals is the Employee Stock Ownership Plan (ESOP).
What Is an ESOP?
An ESOP is a qualified retirement plan designed to invest primarily in the sponsoring company’s stock. Like other qualified plans, ESOPs must adhere to IRS regulations, including contribution limits and fiduciary responsibilities. However, ESOPs have unique features that make them particularly attractive for business owners:
- Annual Valuation: Company stock held in the ESOP must be valued annually by an independent appraiser.
- Corporate Eligibility: Only corporations—both C corporations and S corporations—can sponsor ESOPs.
How ESOPs Work
In a typical ESOP transaction:
- The company makes tax-deductible contributions to the ESOP.
- The ESOP uses these funds to purchase stock from the current owner(s).
- Alternatively, a leveraged ESOP borrows funds to buy the stock, and the company repays the loan through tax-deductible contributions.
Employees participating in the ESOP receive shares over time and enjoy tax-deferred growth. Upon retirement or departure, they can sell their shares back to the company at fair market value, thanks to a built-in “put option.”
Key Benefits of ESOPs
For Business Owners
- Liquidity and Diversification: Selling shares to an ESOP provides liquidity and allows owners to diversify their assets, which is crucial for estate planning and financial security.
- Tax Deferral: C corporation owners can defer capital gains taxes by reinvesting proceeds into qualified replacement securities. If held until death, these gains may be permanently avoided.
- Retained Control: Owners can remain in management roles and, if serving as ESOP trustees, retain voting rights on key corporate matters.
For the Company
- Tax Advantages: Contributions to the ESOP are tax-deductible. In leveraged ESOPs, both principal and interest on the loan are deductible.
- Employee Incentives: ESOPs serve as a compelling employee benefit, enhancing retention and aligning employee interests with company performance.
Considerations and Costs
While ESOPs offer substantial benefits, they also come with costs:
- Setup and Maintenance: Establishing and administering an ESOP involves legal, financial, and administrative expenses.
- Annual Valuation: Independent stock valuations are required each year, adding to ongoing costs.
Conclusion
An ESOP can be a highly effective tool for business succession and estate planning, offering liquidity, tax efficiency, and continuity. However, due to the complexity and costs involved, it’s essential to consult with financial and legal advisors to determine whether an ESOP aligns with your long-term goals.
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Cheryl has extensive experience working with business owners and individuals on minimizing taxes, with a focus on succession planning. With a thoughtful approach, Cheryl helps clients explore their long-term goals and plan accordingly. Leveraging Cheryl’s expertise in this area, the goal is to implement plans that achieve the wishes of the client and provide for tax-efficient transitions. Cheryl’s passion for working with corporations and individuals has allowed her to become a trusted business advisor. She has worked with clients not only in the Western New York region but also throughout the country. The breadth of this experience has allowed her to collaborate with other professional advisors to ensure that plans are flexible and innovative in the ever-changing world in which we live. Cheryl started her career with the Firm in 1991 and rejoined in 2019 adding additional strength to the tremendous talent of the Lumsden McCormick tax team.