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By Karen Gentry | MiBiz
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GRAND RAPIDS — The best option for business owners looking to sell or transition their business may be an Employer Stock Ownership Plan because of the tax advantages for owners and retirement benefits to employees.

Warner Norcross & Judd LLP Partner Vern Saper believes that in the next two to three years there will be an increasing number of ESOPs because of an improving economy and more Baby Boomers looking toward retirement. Saper, an employee benefits attorney who has been working with employers on ESOPs since the 1970s, planned to speak after press time on “Employer Stock Ownership Plans — Will an ESOP Work for You” at Warner Norcross & Judd offices in Grand Rapids on Sept. 14. The event is sponsored by the Family Business Alliance.

Saper said retiring owners often need to sell their company and can’t afford to give the stock away. Most need to use assets from the sale of their company for their retirement. He said there are generally three possibilities as to who might buy a company — an outsider, current management or family members, or the third option: an ESOP.

Saper said there are often problems involved when an outsider buys a company including a “slash and burn” approach and moving a company outside of West Michigan. With the second option, oftentimes family members don’t have the capital to buy the company.

The ESOP is much preferable from a tax standpoint because under the first two options outsiders or employee/family members have to pay a capital gains tax plus state income tax, currently at about 20 percent, according to Saper.

“If these owners sell to an ESOP and if it’s done correctly, the owners can elect not to pay any tax at all by selling stocks to their employees,” Saper told MiBiz.

He said an ESOP is similar in structure to a 401k plan and has to meet all the same basic rules. The ESOP can borrow money to purchase company stock and then each employee has his or her account under the plan. The ESOP borrows money to buy the stock, and then owns the stock and owes money on the loan.

Each year the company puts money into the ESOP and makes the annual payment on the loan. The money that the company puts into the plan is tax deductible and the ESOP uses that money to repay the loan.

Saper emphasized the three major tax advantages with ESOPs. The owner can sell his stock and elect not to pay any taxes. Secondly, the ESOP can buy their stock using tax-deductible dollars.

“The company can get a tax deduction for putting money in the plan. You’re buying stock with pre-tax dollars, which is cost-efficient,” Saper said. “What you’re doing is repaying a bank loan with tax-deductible dollars and no place else under the tax law can you do that.”

A company converting from a C corporation to an S corporation is the third major tax advantage.

The ESOP as an S corporation is a tax-exempt entity — the stock that’s owned by the ESOP escapes taxation. If a company puts $1 million into the ESOP it may only cost the company about $600,000-$700,000 because of the tax deduction of about 33 percent.

“No one pays income tax on the profits of the company — that’s huge. Many of the companies have gone ESOP because of this rule,” Saper said.

He advises businesses interested in exploring ESOPs to consult a qualified attorney, although Saper noted there are not that many professionals that are aware of what an ESOP can offer. Saper said there are close to 100 companies in West Michigan that have ESOPs. Saper said that profitable, privately held companies with a minimum of 25-30 employees are good candidates for ESOPs.

An ESOP can boost employee morale and productivity, although it depends on how well the plan is communicated to employees, according to Saper.

“The more the company increases in value, the larger the retirement benefit the employee will receive,” Saper said.

ESOPs have been around since 1974, although most didn’t jump on the ESOP bandwagon until the 1980s after Congress passed favorable legislation to encourage owners to sell to their employees, Saper said.

Haviland Enterprises Inc. in Grand Rapids has been an ESOP since 1996. Owner Dick Garner wanted to keep the family business running and offer retirement benefits to employees, according to Haviland Enterprises CFO Terry Schoen. Currently, the ESOP owns about 46 percent of Haviland stock.

“We’ve been slowly buying it and there’s an annual distribution to the employees,” Schoen said. “The value of stock has risen very nicely over the last couple of years.”

Schoen said the ESOP offers a controlled transition with tax advantages and a good retirement vessel for employees.

“It’s a rare win-win on both sides of the political spectrum,” said Schoen, noting the tax advantages for the owner, the transition of company ownership and stock offerings to workers.

Saper recommends the ESOP Association website (www.esopassociation.org/) as a source of good information.

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