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To begin with, the ESOP will have to borrow the money in the same way the corporation would; yet
the ESOP has no credit record or assets to pledge as collateral. This is normally overcome, however,
by the corporation‟s giving the lender a secured guarantee of the ESOP‟s obligation. Thus, the
corporation ends up in the same economic position it would have enjoyed under a direct redemption.
Morris might also object to the amount of control an ESOP might give to lower-level employees of
Plant Supply. After all, his intent is to leave the corporation under the control of Lisa and Brad, but
qualified plans must be operated on a nondiscriminatory basis. This objection can be addressed in a
number of ways. First, the allocation of shares in proportion to compensation, along with standard
vesting and forfeiture provisions, will tilt these allocations toward highly compensated, long-term
employees, such as Lisa and Brad. Second, the shares are not allocated to the employees‟ accounts
until they are paid for. While the lender is still being paid, an amount proportional to the remaining
balance of the loan would be controlled by the plan trustees (chosen by management). Third, even
after shares are allocated to employee accounts, in a closely held company, employees are allowed to
vote those shares only on questions that require a two-thirds vote of the stockholders, such as a sale or
merger of the corporation. On all other more routine questions (such as election of the board), the
trustees still vote the shares. Fourth, upon employees‟ retirement and before distribution of their
shares, a closely held corporation must offer to buy back the distributed shares at fair market value. As
a practical matter, most employees will accept such an offer rather than move into retirement with
illiquid, closely held company stock.
If Morris accepts these arguments and opts for an ESOP buyout, the following benefits accrue.
Rather than being able to deduct only the interest portion of its payments to the lender, the corporation
may now contribute the full amount of such payment to the plan as a fully deductible contribution to a
qualified plan. The plan then forwards it to the lender as a payment of its obligation.
Furthermore, the Internal Revenue Code allows an individual who sells stock of a corporation to the
corporation‟s ESOP to defer paying any tax on the proceeds of such sale if the proceeds are rolled
over into purchases of securities. No tax is then paid until the purchased securities are ultimately
resold. Thus, if Morris takes the money received from the ESOP and invests it in the stock market, he
pays no tax until and unless he sells any of these securities, and then only on those sold. In fact, if
Morris purchases such securities and holds them until his death, his estate will likely receive a step-up
in basis for such securities and thus avoid income tax on the proceeds of his company stock entirely.
Estate Planning
Should Morris rebel at the thought of retiring from the company, his thoughts may naturally turn to the
tax consequences of his remaining employed by the company in some capacity until his death.
Morris‟s lifelong efforts have made him a rather wealthy man, and he knows that the government will
be looking to reap a rather large harvest from those efforts upon his death. He would no doubt be
rather disheartened to learn that after a $3.5 million exemption (in 2009), the federal government will
receive up to 48% of the excess upon his death. Proper estate planning can double the amount of that
grace amount by using the exemptions of both Morris and his wife, but the amount above $7 million
appears to be at significant risk, and that risk will likely increase when Congress turns its attention to
years following 2009.