Summary of ESOP Incentives

Corporate Tax Benefits
A C-Corporation with an ESOP receives tax deductions for making contributions to the ESOP. In a leveraged ESOP, the ESOP receives a loan and uses the proceeds to purchase a block of stock from current shareholders. (The loan is frequently made to the corporation by a bank and/or investors, and then the company re-lends the money to the ESOP. The corporation which sponsors the ESOP guarantees the ESOP debt.) The company or selling shareholder(s) can, if desired, also provide some of the financing. The stock purchased by the ESOP is held by the ESOP Trust for the benefit of eligible employees. As the C-Corporation makes tax deductible contributions to the ESOP to repay the debt, shares held in the ESOP Trust’s suspense account are allocated to the employee’s accounts at a rate corresponding to the debt amortization. Plan participants then vest in the shares allocated to their account under normal ERISA vesting schedules.

Tax-Free Corporate Operations
As advantageous as the above corporate tax benefits are, there are even more substantial tax advantages for an S-Corporation with an ESOP. The income attributable to S-Corporation stock owned by an ESOP is not subject to federal income tax. All but three state’s (CT, MI, TN) tax codes mirror this provision. For example, if an S Corporation were 40% owned by an ESOP, then 40% of the company's income would be tax-free. If the company were 100% ESOP owned, then the company would pay no tax. This is not a deferral; the corporate tax liability is eliminated entirely. Unique debt and equity structures, which capture the full tax and incentive benefits of an ESOP, typically form the “backbone” of Intrepid Capital Group’s buyout financings.

Individual Tax Benefits to Sellers
Individual or family owners of privately held companies are frequently eligible for tax deferred (tax-free) rollover treatment when they sell their interests or stock to an ESOP. Individuals (or partnerships, trusts, etc.,) who own interests in a closely held business entity may be eligible for such rollover treatment under IRC Sec 1042, provided that the initial sale to the ESOP is for an ownership stake of 30% or greater, and such shareholders otherwise qualify. The other requirements include ownership of the business interest for at least three years, and reinvestment of the proceeds from the sale to the ESOP in stocks or bonds of U.S. operating companies within three months before or twelve months after the sale to the ESOP.

Sellers may not qualify to elect the 1042 rollover for a variety of reasons. While most technical issues related to qualification can easily be met, some common disqualifying fact patterns include: (a) the sellers may have received their interests or stock through some form of stock option plan or other method that makes them ineligible; (b) the interests or stock may be owned by a corporation; or (c) the company may be publicly held. In these instances, the interests or stock sold to the ESOP would be subject to long term capital gains tax treatment, provided the one-year holding period is satisfied.