An ESOP may serve as a vehicle to create a market for stock of shareholders of closely-held corporations. The ESOP is a mechanism that enables these shareholders to sell all or a portion of their shares to management and the employees. Shareholders have the flexibility to integrate their estate and financial needs as they sell all, or part of their holdings to an ESOP. 

An ESOP is a defined contribution plan that provides retirement benefits to eligible employees of a company. The most important difference between an ESOP and any other type of defined contribution plan is that the ESOP is designed to invest primarily in stock of the company, and to borrow money for the sole purpose of using the loan proceeds to purchase stock of a company. As a result, the employees are given the opportunity to own all or part of a company and to participate in the growth and success of their company. 

There are tax advantages for both the business and the employees when an ESOP is created. Businesses are allowed an annual deduction of up to 25% of covered compensation for payments into the ESOP. As the employee is distributed shares of stock in the ESOP, that stock grows tax deferred. When the employee chooses to leave the company, they will be paid by the company for their vested stock. 

ESOP Facts:

  • Employees can join an ESOP plan after they have completed 1 year of service for the company or 1,000 hours of service within 1 year.
  • According to recent studies, sales, productivity, and profitability improve after an ESOP is adopted by a company.
  • The majority of ESOPs are sponsored by closely held companies.
  • ESOPs are permitted to borrow money to acquire plan assets.