It is generally acknowledged that ESOPs were created with the passage of ERISA. ESOPs enjoy many of the advantages of other qualified retirement plans including qualified plan assets contributed to the plan may compound and grow free of all taxes until the assets are withdrawn. A specific advantage to an ESOP in a C Corporation is a shareholder selling stock to the ESOP may qualify for an Internal Revenue Code Section 1042 "tax free rikkiver" of the proceeds received from he sale. To qualify for the tax free rollover, the ESOP has to own at least 30% of the outstanding stock after the transaction is completed. The tax free rollover is a powerful incentive because a selling shareholder is typically exposed to a 20% capital gains tax on the taxable sale proceeds. The proceeds from the sale to the ESOP have to be reinvested (rolled over) into qualified domestic securities for the tax deferral.
Up until 1998, the plan sponsor or employer of an ESOP had to be a Corporation. S Corporations were barred because S ownership was not available to a trust and virtually all qualified retirement plans must have a trust that typically owns the plan assets for the benefit of plan participants. In 1998 the ESOP became available to S corporations when trusts were approved for S ownership.
A C corporation still offers some major advantages by allowing multiple stock classes. Dividends can be contributed to the ESOP and they re tax deductible by the corporation. The Section 1942 tax free rollover is not available with an S Corporation. Any gain on the sale of the stock to an ESOP in an S corporation is taxable to the selling shareholder.