The S Corporation ESOP structure

Due to a recent (1997) amendment to ESOP legislation, additional incentives were created that encourage outside capital sources to partner with employee groups to achieve employee ownership. This 1997 amendment to ESOP legislation allows for the creation of Subchapter “S” Corporations where the ESOP Trust (or “ESOT”) is the sole or primary shareholder of a corporation. By electing “S Corporation” status, these companies, like all other S Corporations throughout the United States operate on a “tax-free” basis at the Federal level. To be clear, tax obligations do not disappear for individual participants in S Corporation ESOPs. When those participants leave or retire from an ESOP employer, they must either roll their account value into another tax favored plan such as an IRA (and eventually pay taxes when that plan is cashed in) or, if departing ESOP participants choose to immediately cash out their accounts, they must pay taxes on the balance in their respective accounts at the individual rate. To summarize, 100% S Corporation ESOPs operate free of Federal tax. Individual ESOP participants, however eventually do pay individual income taxes on the value of their ESOP accounts.