Employee Ownership Trusts (EOTs) vs. ESOPs for Business Succession and Transition: Which Is Right for You?

Overview: What Employee Ownership Trusts Are and How They Work vs. ESOPs

An ESOP Is a Specific, Highly Regulated Retirement Plan; an EOT Is a Simple Trust

Like a 401(k), an ESOP is a defined contribution retirement plan for employees, but unlike a 401(k), it is designed to primarily invest in company stock. The company contributes stock, or cash to buy stock from existing owners, to a trust that owns the stock and holds it in accounts for employees. Employees vest in their accounts over time. ESOPs can be complex and expensive due to regulation as tax-qualified retirement plans under the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA), but they offer strong tax incentives.

In contrast, an EOT is not a retirement plan but instead a permanent trust that buys shares from the company owners and never distributes them. EOTs are much simpler and relatively inexpensive; because an EOT is not a benefit plan but instead simply a new owner that does not have accounts for or make distributions to employees, it does not have all the layers of legal rules that ESOPs do. On the other hand, it does not offer the ESOP's tax benefits. In recent years, the EOT concept has begun to spread in the US.

EOTs became prominent as a form of employee ownership in the UK, where they are a leading form of employee ownership. In contrast to the US, the UK has EOT legislation with legal requirements and tax benefits but does not have something comparable to the US ESOP. The flagship EOT in the UK is the iconic retailer John Lewis, which became owned by an employee trust in 1929.

The infographic below compares EOTs to ESOPs in the US.

In Both ESOPs and EOTs, the Trust, Not Employees, Is the Legal Owner of the Stock

The trust (with the trustee being the shareholder of record) owns the shares in the ESOP trust; the employees are beneficial owners of shares in their ESOP accounts.

As with an ESOP, the EOT (with the trustee as the shareholder of record) owns and holds the stock, not individual employees. Unlike an ESOP, employees do not have individual claims to or beneficial ownership of EOT-held shares.

An ESOP Pays Employees the Value of the Stock After They Terminate; an EOT Company Shares Profits During Employment

ESOP participants are paid out the stock in their account or its cash value, generally after leaving the company. Many ESOP companies do have some form of profit sharing as well.

An EOT does not distribute its shares to employees or give them any other equity interest in the trust, but EOT companies typically pay profit sharing or a similar bonus to current employees.

Taxes: An Employee Ownership Trust Lacks ESOP Incentives

ESOPs Allow Selling Owners to Avoid Taxation; EOTs Do Not Offer Seller Tax Benefits

In C corporations, an owner selling to an ESOP can indefinitely defer taxation under Section 1042 of the Internal Revenue Code on the gains from the sale if certain requirements are met and the seller reinvests the gains in qualifying US securities. If the securities are held until death, there is a step-up in basis, and no taxes are due.

In contrast to ESOPs, employee ownership trusts do not provide tax benefits to the seller.

ESOP Contributions Are Tax-Deductible, and ESOP-Owned S Corporations Have No Tax Burden; EOT Contributions May Be Tax-Deductible

The company's contributions to the ESOP (including both principal and interest when repaying a loan for the ESOP to purchase shares) are tax-deductible and thus are pretax, unlike a stock redemption outside of an ESOP, which would be funded in after-tax dollars. In S corporations only, the ESOP trust is tax-exempt, so if the ESOP fully owns the company, there are no tax bills to fund with distributions.

The company's contributions to an EOT are normally not tax-deductible. EOT companies often pay profit sharing to employees, which is deductible as an expense. If the purchase is financed with debt, the interest, but not the principal, is deductible.

ESOP Participants Pay No Tax Until Receiving Distributions, and Even Then Can Defer Tax by Rolling Them Over; EOT Profit Sharing Is Taxed When Received

As with other tax-qualified retirement plans such as 401(k)s, ESOP participants pay no tax on the contributions to the trust until they receive a distribution of their account balances, generally after ending employment. At that point, employees can further defer taxes by rolling over the distribution into an IRA or other retirement account.

EOTs often pay annual profit sharing, which is taxable to employees when received the same way a bonus is, i.e., subject to payroll taxes.

Employee Coverage, Allocations, and Payouts

ESOPs Usually Include All Full-Time Adults; EOTs Similarly Include Most or All Employees

Most employees aged 21 or older who have completed a year of service with 1,000 or more hours must be included in an ESOP, and usually all are. Companies may choose to include employees earlier. Some workforce segments may be excluded.

Companies can choose which employees they want to include in EOT benefits (such as profit sharing), but most EOTs include most or all employees.

ESOPs Allocate Benefits Based on Relative Compensation up to a Limit; EOTs Choose Formulas for Sharing Profits

Each ESOP participant is allocated annual company contributions to the plan based on their relative compensation among fellow eligible employees or a more level formula. Pay over a certain amount ($360,000 as of 2026, indexed annually) does not count in this calculation.

EOT companies choose their own formulas for profit sharing. If the company is sold, any equity value is generally divided between those who are employed at the time of sale, based on a formula the company determines. Companies can choose to set up some kind of equity-sharing plan, such as stock options, restricted stock, or synthetic equity, in addition to the EOT.

ESOPs Vest Employees As in Other Retirement Plans; This Concept Does Not Apply to EOTs

Vesting is the amount of time an employee must serve before acquiring an unconditional interest in their benefit. ESOP vesting can either be gradual, starting after no more than two years of service and reaching 100% after no more than six years of service, or sudden ("cliff" vesting), reaching 100% immediately after no more than three years of service. A year of service is a plan year with 1,000 hours of service or, if the company chooses, a smaller number. Also, participants must become 100% vesting after they reach retirement age.

Because there are no equity allocations with an EOT, vesting does not apply there.

ESOP Participants Are Paid Their Accounts After Termination; EOT Company Employees Receive Profit Sharing While Employed

Distribution of ESOP participant account balances generally must start no later than five years after the end of the plan year except for terminations due to death, disability, and retirement, in which case distribution must start no later than one year after the end of the plan year.

Since EOT company employees do not have accounts in the trust, there is no question of receiving a distribution from the pool of shares. Instead, EOT company employees generally receive profit-sharing rewards (a percentage of the company's annual profits) while they remain employed.

Running the Plan: Employee Ownership Trust Freedom vs. ESOP Rules

An ESOP Need Only Provide Minimal Voting Rights to Participants; Rights Under an EOT Are at the Company's Direction

The ESOP trustee is appointed by the board. The trustee (as the shareholder of record) votes the shares. Employees have limited voting rights (except in public companies) unless the company chooses to provide greater rights.

Companies with an EOT can choose the control rights the trust exercises and whether employees have any say. The seller generally determines the purpose under which the trust must operate and what role the employees have in governing the trust. Most EOTs are designed to be permanent, however, so that the company is not sold.

An ESOP Cannot Pay More Than Fair Market Value for Shares; There Are No Rules for EOTs

The ESOP trust cannot pay more than fair market value, defined as what a willing financial buyer would pay for the percentage of the company the ESOP trust is purchasing. In private companies (where most ESOPs are), this is based on a report from an independent appraiser hired by the ESOP trustee. Appraisals must be done annually. ESOPs generally can pay what most other financial buyers would pay, but about 10% to 20% of potential sellers to ESOPs could get a substantial premium by selling to a synergistic buyer instead.

There are no rules for how EOT-held shares are appraised, although a valuation is advisable.

The ESOP Trustee Must Ensure the Plan Is Run in the Participants' Best Interests; EOT Fiduciary Issues Depend on State Law

The ESOP trustee is responsible for assuring that the plan is operated in the best interests of plan participants. This includes making sure the appraisal is done properly and that the plan operates within its rules and the requirements of the law.

Fiduciary issues for an EOT depend on the state law governing the trust.

Costs, Financing, and Complexity: Employee Ownership Trust Simplicity vs. ESOP Complexity

An ESOP Usually Costs $150,000 or More to Create, with $20,000 or More in Yearly Costs; EOTs Cost $30,000 or More to Create, with Minimal Ongoing Costs

A leveraged ESOP (i.e., one using a loan to buy a large block of stock) generally costs between $150,000 and $300,000 to set up but can cost more in larger and complex deals. (In a 2024 NCEO ESOP transaction survey, 76% of respondents said their ESOP transaction was leveraged.) Nonleveraged ESOPs have much lower setup costs. Costs are generally less than the costs of selling to a third party. Ongoing costs such as valuation and administration are about $20,000 to $30,000 annually for most ESOPs, with costs going up with size.

Initial costs to set up an EOT are generally from $30,000 to $100,000; ongoing costs are not significant.

Both ESOPs and EOTs Are Financed by the Company, Not the Employees

ESOPs are paid for (both to set the plan up and to buy stock) by the company, not the employee-participants. ESOPs can be financed by annual cash contributions to the plan in a gradual sale or by leverage when the ESOP buys a large block of stock up front. ESOP loans can come from seller notes, banks, and/or mezzanine lenders.

As with an ESOP, an EOT is funded by the company, both to create the trust and to buy out the owner(s). Most are funded by seller notes.

ESOP Benefits Come at the Cost of Complexity for a Business Transition

ESOPs are subject to complicated federal rules. (However, although they are more complicated than other employee ownership plans such as EOTs, a sale to an ESOP is less complicated than a sale to another company.)

Because EOTs are not covered by any specific set of rules, they are less complicated and more flexible than ESOPs to set up and administer.

So Who Should Use Which Plan for Business Succession?

ESOPs Are Most Often Used for Tax-Advantaged Buyouts; EOTs Provide a Permanent Solution That Avoid Costs and Complexity

The classic use of an ESOP is to provide a partial or complete ownership transition in an established company. Sometimes they are created simply to share the wealth with employees. The company must be a C or S corporation or an LLC taxed as a C or S. While some ESOPs are in public companies, over 90% of ESOPs are in private companies, and this discussion focuses on them.

Companies using an employee ownership trust instead of an ESOP or other alternative often seek an ownership transition that provides legal protection for preserving the selling owner's legacy, benefiting the community, or advancing social and environmental goals. The EOT can be designed as a permanent trust that will not sell to another buyer, which may not be possible with an ESOP, although it is rare for an ESOP company to be sold if it does not want to be sold. Companies also use EOTs to avoid the rules and costs of an ESOP at the cost of forgoing its tax benefits.

ESOPs Don't Fit in Small Companies Where the Cost Is Prohibitive; EOTs Don't Fit Where ESOP Tax Benefits Are Desired

Because they are expensive to implement and manage, ESOPs generally do not work for companies with fewer than 15 to 20 employees. They also do not work if the company is not profitable enough to fund the ESOP on an ongoing basis. An ESOP is inadvisable if the company is uncomfortable with employees becoming owners. The company must also realize that ESOP benefits cannot be awarded on a discretionary basis; any discretionary awards would be non-ESOP equity grants or bonuses outside the plan.

(This is not to imply that employee ownership trusts are only for small, or even small-to-medium companies. In the US, Consumer Direct Care announced in the fall of 2025 that an EOT now owned over 30% of its shares; according to reports, the EOT is on track to cover up to 60,000 employees within a few years. In the UK, the John Lewis EOT mentioned above covers over 74,000 employees.)

If the selling owner and/or company seek a tax-favored way of providing liquidity and ownership transition, an EOT is a poor choice because it does not provide the ESOP's tax benefits.