Another use of an ESOP is to reduce the cost of existing employee benefits drastically. Assume that ABC has a profit-sharing plan and that normal annual contributions amount to $100,000. The company would like to reduce the cash cost of employee benefits without reducing the value of the annual contribution.
This goal can be accomplished through an ESOP The first step would be for ABC to create an ESOP for the purpose of holding corporate securities. The company then would reduce its cash contributions to the profit- sharing plan by, say, 50%. The additional $50,000 in value would be contributed to the ESOP in the form of corporate stock. The employees receive an equivalent contribution, but the cost to the company has been reduced by more than 75%.
Here's how it works: If the company were to make the planned cash contribution of $100,000, the after-tax cost would be $66,000, assuming a 34% marginal tax rate. By using an ESOP, the company is still getting a $34,000 tax deduction in that both the cash contribution and the stock are deductible. The difference is that now the $34,000 deduction is taken against a $50,000 cash outlay; therefore, the after-tax cash cost of the transaction is only $16,000 ($50,000 - $34,000). The change from $66,000 to $16,000 is more than 75%.
By using this technique, a company can continue an equivalent level of benefit plan contributions while reducing its after-tax cash costs by more than 75%.
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