What’s an ESOP
Employers and employees can work together for a common goal. Providing benefits for workers is one way to gain employee loyalty. One of the most popular benefits that employers can offer employees is what is known as a Employee Stock Ownership Plan or ESOP. An ESOP offers benefits for both employee and employer. Company owners can take advantage of tax breaks while employees get rewarded for their hard work. Employee ownership can take a great many forms. Employees may choose to buy stock directly on their own or get access to stock as part of a bonus plan. They can also get stock options and be part of a worker cooperative or profit sharing. Of all these, it is the ESOP that is by far the most common. There are more than six thousand plans that cover over fourteen million people.
A Variety of Reasons
ESOPs are used for varied reasons. They are often used to reward employees and assist companies by providing capital so they acquire new assets. They are a contribution by the employer to the employee and not meant to be something the employee purchases on their own. It is important to understand that these plans must follow certain rules. The ESOP is similar to profit sharing plans. Companies set up a trust fund. This can be used to buy existing stock or issue new shares. The fund can also borrow money to purchase company shares. This buying process is funded by the company. Company managers benefit because such contributions, within certain limits, are tax deductible. All company managers and owners must be aware of the limits of these plans and must make sure all rules governing them are followed precisely.
One of the reasons these plans have become so popular since they were first implemented in the 1970’s is because they can help companies and employees achieve certain goals. One of the most common is when someone leaves the company. A privately held company can create an immediate market for shares when an owner leaves. Another useful advantage of the ESOP is the ability to borrow funds. Funds can be borrowed at lowered cost after the ESOP directly borrows cash to buy stocks. Under the terms of the tax code, both the principle used to buy the stocks and the employer contribution are tax deductible. Companies can also use them to reward their valued employees. Companies can choose to use this benefit in many ways. They can issue what are known as treasury shares directly to the ESOP and then deduct such costs from their taxes. They can also add cash to the fund that is used to buy existing company shares from the public or from privately held stock. A company can decide to match employee contributions with stock rather than direct cash funding, allowing them to provide their employees with a greater benefit than simply handing out annual bonuses.
An ESOP has certain tax benefits which is why they are so attractive for many modern companies. Stock and cash contributions are largely tax deductible. The same is true of all loans taken out to buy company stock. All dividends are also tax deductible as are employee contributions to the ESOP funds. Employees can turn these into an IRA or 401k and enjoy additional tax benefits when they retire. There are certain drawbacks. Setting up an ESOP can be costly. They cannot be used for certain companies such as partnerships. Companies need to buy corporate shares when an employee leaves, leading to yet further expenses.