Sitting There In Plain Sight: Best Tax Strategy Is The Best Business Strategy
Putting your 2013 taxes behind you, if you’re a founder, entrepreneur, owner or CEO of a privately-held business, now’s the time to start thinking long-term and seriously about taxes, ownership structure (yes, that includes an exit strategy) and how to turbocharge productivity and growth in your business.
You can improve your standing in all three areas by adopting an Employee Stock Ownership Plan, or ESOP, and I’ll get right to the tax savings:
–If you sell 30% or more of your business to a C-Corporation ESOP, you can defer taxes on the proceeds by re-investing in qualifying equities. That’s right, capital gains taxes are deferred while you hold onto those new stocks. Suppose it’s time to start diversifying, and you sell 30% of your firm to an ESOP for $30 million. You can invest that sum in growth stocks, dividend stocks on Stocktrades or some other group of equities to satisfy your personal financial goals. If you sold that 30% to another buyer for the same amount, and as the founder your cost basis is near zero, your federal capital gains, state and other taxes could reach 25% or more, $7.5 million right off the bat. That makes selling your business painful.
–In another example, suppose your underlying company is an S-Corporation (a pass-through vehicle, much like a partnership). An ESOP is a valid shareholder of an S-Corporation and it doesn’t pay federal income taxes. So, the ESOP’s ownership share (which can range from 5% to 100%) is sheltered from income taxes until employee-owners start withdrawing funds in retirement or after they leave the company. That reduces cash out-the-door at your business now.
Those two elements of the ESOP tax benefits are enormous advantages, but they likely won’t be as big as the operating gains your business enjoys as an ESOP, research suggests.
“I’m always amazed that more companies don’t recognize the power of associate ownership,” Ed Crenshaw, the CEO of Publix Super Markets, told Forbes last year. Publix is the nation’s largest ESOP, measured by number of employees. Crenshaw and his family own about 20% of the chain, which dominates the Florida market with famously good service, and employees own the remainder.
Indeed, employee-owned companies tend to receive a productivity boost as workers think and act like owners. People work harder. Waste and other anti-productive behavior is reduced by a self-policing effect among workers. Smart ideas surface more frequently. Business owners have experienced it. I’ve seen it repeatedly in a career of helping companies convert to ESOP ownership. And decades of ESOP studies confirm it.
Employee ownership is also associated with greater business stability and a lower level of insolvencies. Owning a piece of the company typically results in greater employee job satisfaction and that can help reduce costly turnover. All of this boosts the value of the business over time, so that owners – the original entrepreneur and the employees, whatever percentages they hold – have a piece of an expanding pie. More than 10,000 companies in the U.S. are ESOP-owned.
For your employees, an ESOP leads to far greater retirement savings than they’d otherwise have. Beyond Social Security, just 40% or so of U.S. workers participate in a workplace retirement plan. Even among those who do, they tend to put aside too little, and are too inclined to withdraw money early from 401k and other plans. The result: more than half of workers have less than $25,000 put aside, and collectively the gap between retirement needs and savings measures is in the trillions of dollars and growing steadily.
An ESOP is a way to make sure your employees aren’t part of those depressing statistics. And it could make you a lot happier come tax time.