Key Facts About S ESOPs
What is an S Corporation ESOP?
A Sub-chapter S corporation is a business entity that provides flow-through tax treatment to its shareholders. An employee stock ownership plan (“ESOP”) is a qualified defined contribution plan that provides a company’s workers with retirement savings through their investments in their employer’s stock, at no cost to the worker.
ESOPs are regulated by the Employee Retirement Income Security Act (“ERISA”) just like pension funds, 401(k) plans, and other qualified retirement plans. Congress authorized the S corporation ESOP structure to encourage and expand retirement savings by giving hundreds of thousands of American workers in all 50 states the opportunity to have equity in the companies where they work. Today S ESOPs accomplish exactly what Congress intended them to do: create jobs, generate economic activity and promote retirement savings.
Data Supports the Tremendous Value S Corporation ESOPs are for Workers and the Economy
A joint ESCA – National Center for Employee Ownership (NCEO) study demonstrates how U.S. states can support employee ownership by extending tax breaks to business owners selling to an ESOP, providing loan guarantees and loan funds for ESOP loan providers, and creating purpose-built Offices of Employee Ownership, among other policies. The report notes that there are almost 7,000 ESOPs across every major industry that employ more than 13 million workers. Moreover, there are at least eight ESOPs located in every state across the country, with states like California, Ohio, and Vermont fostering further growth through dedicated employee ownership offices.
Data compiled by Ernst and Young’s Quantitative Economics and Statistics (QUEST) practice shows that S corporation ESOPs outperformed the S&P Total Returns Index in terms of total return per participant by an impressively large margin (62%), net assets of S ESOP accounts in the aggregate increased over three-fold, and retirement distributions to workers in S ESOPs totaled nearly $30 billion from 2002 to 2012.
Jared Bernstein, former chief economist for Vice President Joe Biden, also found that by increasing capital ownership, employee stock ownership plans (ESOPs) reduce wealth inequality, and, if plans were to proliferate, more workers across the country would benefit from the equalizing effects of ESOPs. Bernstein’s report also finds that ESOPs do not have the effect of trading employee wages for ownership shares. In fact, the report argues that as employee ownership rises, wage inequality also falls.
In June 2014, data compiled by the National Center for Employee Ownership (NCEO) shows that private employee-owned businesses have strikingly fewer loan defaults than other businesses. NCEO finds that the default rate on bank loans to ESOP companies during the period 2009-2013 was, on average, an unusually low 0.2 percent annually. By contrast, mid-market companies in the U.S. typically default on comparable loans at an annual rate of 2 to 3.75 percent. The tenfold difference between the economic strength of employee-owned companies and other businesses highlights the fact that private businesses which are owned by their employees have the incentives and vision that makes them more stable, more successful, and better for employees as well as the larger economy.
In April 2013, Alex Brill, tax adviser to the Simpson-Bowles deficit reduction commission, introduced a new study looking at the “Macroeconomic Impact of S ESOPs on the U.S. Economy.” Key findings from this report reveal that:
- The number of S ESOPs and the level of active participation (number of employee-owners) have more than doubled since 2002.
- The total output from S ESOPs and the industries they support is nearly 2 percent of GDP.
- S ESOPs directly employ 470,000 workers and support nearly a million jobs in all.
- S ESOPs paid $29 billion in labor income to their employees, with $48 billion in additional income for supported jobs.
The new study preceded a 2012 study by Brill that found:
- Employment among surveyed S ESOP firms increased more than 60% from 2001-2011, while the private sector as a whole had flat or negative growth in the same period.
- In the struggling manufacturing industry in particular, the S ESOP structure has buffered against economic adversity and job loss.
- S ESOPs have significantly expanded the pool of US workers who are saving for retirement, while also boosting company productivity – something that has greatly benefited their employee-owners.
Brill notes that “in the context of the current tax reform debate that seeks to curtail existing tax expenditures in favor of lower statutory rates, policymakers should recognize the evidence in support of S ESOPs and their positive economic contribution.”
His study reinforces what earlier economic analysis of S ESOPs has found. For example, in a 2010 Georgetown University/McDonough School of Business study, two leading tax economists reviewed the performance of a cross-section of S corporation ESOP companies during the recent recession and found that these companies performed better than other companies in job creation, revenue growth, and providing for workers’ retirement security.
Specifically, the study found that:
- Companies that are S corporation ESOPs are proven job-creators, even during tough times. While overall U.S. private employment in 2008 fell by 2.8%, employment in surveyed S corporation ESOP companies rose by 2%. Meanwhile, 2008 wages per worker in surveyed S corporation ESOP companies rose by 6%, while overall U.S. earnings per worker grew only half that much.
- S corporation ESOP companies provided substantial and diversified retirement savings for their employee-owners at a time when most comparable companies did not. Despite the difficult economic climate, surveyed S corporation ESOP companies increased contributions to retirement benefits for employees by 19%, while other U.S. companies increased their contributions to employee retirement accounts by less than 3%.
A 2008 University of Pennsylvania/Wharton School of Business study found that S ESOPs contribute $14 billion in new savings to their workers each year beyond the income they would otherwise have earned, and that S corporation ESOPs offer workers greater job stability and increased job satisfaction. The study also found that S corporation ESOPs’ higher productivity, profitability, job stability and job growth generate a collective $19 billion in economic value that otherwise would not exist.
Statistics clearly demonstrate that S ESOPs are a major force in providing retirement security to workers. A 2005 NCEO survey reported that S corporation employee-owners had ESOP account balances three to five times higher than the U.S. average for 401(k) plan participants. For S corporation employee-owners nearing retirement, ESOP account balances were five to seven times the average. Some 80 percent of companies surveyed by NCEO offer their employees more than one qualified retirement plan.
The benefits of S ESOPs are particularly important given Congress’ task of addressing the difficulties plaguing the U.S. economy, working Americans, and their families. Given this, more should be done to preserve and expand employee ownership in S corporations to provide the benefits of this structure to more working Americans.