As a business owner, you’ve built something worth protecting—not just for your family, but for your employees and the community you serve. When it’s time to step away, who will carry it forward? For owners who aren’t passing the business to family, an Employee Stock Ownership Plan (ESOP) may offer a powerful alternative. In this article, we explore how ESOPs work, the tax benefits they offer, and why more business owners are considering them as part of their succession and legacy strategy.
This type of qualified retirement plan that enables a business owner to gradually transfer ownership shares to employees. Moreover, establishing an ESOP sets up opportunities for the owner of a closely held business to cash out (in whole or in part) in the future, while keeping the company going for employees and the community.
An ESOP may be a good option for small-business owners who don’t plan to pass the reins to family members when they retire, but instead have loyal and capable managers who would be interested in taking over the company. In the meantime, an ownership mentality may enhance efficiency and productivity, because employees have a stake in the company’s long-term success.
How ESOPs work
ESOPs are designed to invest their assets primarily in company stock rather than investing in the public markets. Annual cash contributions are made to the ESOP and used to purchase stock from the company, or the company may contribute the stock directly. In either case, the company can take a tax deduction for the value of each year’s contribution, while the cash stays with the company.
Unlike other retirement plans, ESOPs are permitted to borrow money to purchase company stock. The company then makes annual contributions to the ESOP in the amount equal to the ESOP’s principal and interest payments on the loan and uses the contributions to pay back that debt. The company’s contribution as a whole is deductible, so the interest and the principal on the loan are deductible as well.
With an ESOP, an employee never buys or holds the stock directly while still employed with the company. If an employee is terminated, retires, becomes disabled, or dies, the plan will distribute the vested shares of stock in the employee’s account.
ESOP participants are investing heavily in a single stock, and their investment is tied to the financial health of the business. If the company declines in value, the ESOP may also. Thus, an ESOP should generally be offered alongside a standard retirement plan [such as a (401k)] with more diversified investment options.
A tax-deferred exit
There may also be tax benefits for a retiring owner who sells a business to an ESOP. If the ESOP owns at least 30% of the company after the sale, the capital gains tax on the sale may be deferred by reinvesting the proceeds in domestic U.S. securities (“qualified replacement property”). No tax would be due until the replacement securities are sold. If they are held until death, a stepped-up basis may apply, and the original gain may never be taxed.
In It Together
At last count, 6,548 businesses had ESOPs holding more than $1.8 trillion in assets, covering more than 14.9 million employees.
Number of ESOPs in the United States, and share of total (2022)
Source: National Center for Employee Ownership, 2025
(percentages rounded to the nearest whole number)
Business owners can defer taxes on the sale of business interests to an ESOP only if the shares were held for at least three years, and if the ESOP was established by a C corp (not an S corp). Among other conditions, stock bought by the ESOP may not be allocated to the seller or certain members of the seller’s family, or to any shareholder of the company establishing the ESOP who owns more than 25% of any class of company stock. If this rule is violated, the company would be subject to a 50% excise tax, and the person receiving the allocation would also be subject to tax consequences.
ESOPs can be complicated and costly to establish and maintain, but they offer significant tax advantages that make them worthwhile in certain situations. It would be wise to consult an attorney with experience in the formation and maintenance of qualified retirement plans to help evaluate whether an ESOP could be appropriate for your business.
The bottom line is this: an ESOP can provide a strategic exit plan, a way to reward your team, and a bridge to retirement—while offering significant tax advantages. But it’s not for everyone. ESOPs come with complexity and require careful planning to implement well. At Stone Oak Wealth, we help business owners explore every angle of their succession plan so they can exit with confidence and clarity—knowing the business they’ve built will continue to thrive in capable hands.
All investing involves risk, including the possible loss of principal. There is no guarantee that any investing strategy will be successful. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
- An ESOP (Employee Stock Ownership Plan) is a qualified retirement plan that allows a business owner to gradually transfer ownership to employees.
- ESOPs work best for owners who don’t plan to pass the business to family but have loyal managers ready to take over.
- The company can deduct annual contributions used to purchase stock – and if the ESOP borrows to buy shares, both principal and interest on the loan are deductible.
- If the ESOP owns at least 30% of the company after the sale, the owner may defer capital gains tax by reinvesting proceeds in qualified replacement property.
- ESOPs are only available to C corps – not S corps – for the tax-deferred sale benefit.
- As of the most recent data, 6,548 U.S. businesses had ESOPs covering more than 14.9 million employees, holding over $1.8 trillion in assets.
- ESOPs are complex and costly to establish – qualified legal counsel with ESOP experience is essential.
Frequently Asked Questions
What is an ESOP and how does it work?
An Employee Stock Ownership Plan (ESOP) is a type of qualified retirement plan that purchases company stock on behalf of employees. The company makes annual contributions – either cash or stock – to the ESOP, which allocates shares to employee accounts over time. When an employee leaves, retires, becomes disabled, or dies, the plan distributes their vested shares. It’s a structured way to transfer ownership gradually while providing employees a stake in the company’s success.
What are the tax advantages of selling to an ESOP?
For the company, annual ESOP contributions are tax-deductible – including both principal and interest if the ESOP borrows to purchase shares. For the selling owner, if the ESOP owns at least 30% of the company after the sale and proceeds are reinvested in qualified domestic securities, capital gains tax can be deferred. If those replacement securities are held until death, a stepped-up basis may apply and the original gain may never be taxed.
Can any business use an ESOP?
Not all businesses qualify for every ESOP benefit. The tax-deferred sale treatment is only available to C corporations – not S corps. There are also ownership restrictions: stock purchased by the ESOP cannot be allocated to the selling owner, certain family members, or shareholders owning more than 25% of any class of company stock. Violations can trigger a 50% excise tax, so proper structure and legal guidance are critical.
What are the risks of an ESOP for employees?
ESOP participants are heavily concentrated in a single stock – their employer’s. If the company declines in value, the ESOP may too. For this reason, ESOPs should generally be offered alongside a more diversified retirement plan, such as a 401(k), so employees aren’t solely dependent on company performance for their retirement security.
Is an ESOP right for my business succession plan?
It depends on your goals, your business structure, the readiness of your management team, and your personal financial situation. ESOPs offer real tax advantages and can be a meaningful way to reward loyal employees while planning your exit. But they’re complex and not right for every situation. At Stone Oak Wealth, we help business owners think through every succession option – including ESOPs – so you can make a decision that honors what you’ve built.
In the Word
Keep your lives free from the love of money and be content with what you have, because God has said, ‘Never will I leave you; never will I forsake you.
Hebrews 13:5
Contentment isn’t found in wealth—it’s found in trust. Money can provide comfort, but only God provides lasting peace and security. When we release the grip of striving for more, we discover the true freedom of knowing we’re never alone.
As you plan for the future, remember that stewardship isn’t about chasing accumulation—it’s about aligning resources with faith, purpose, and gratitude.
At Stone Oak Wealth, we help you build with wisdom, so your life reflects not only success, but deep contentment in the One who provides.
Sources: Broadridge Investment Management Solutions
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