ESOP

In the simplest terms, an Employee Stock Ownership Plan (ESOP) is a retirement plan where the ownership of the company is held in trust for the benefit of the employees of the company. The Trust buys the company on behalf of the employees and uses the profits of the company to pay off the loan used in the purchase.

About two-thirds of ESOPs are used to provide a market for the shares of a departing owner of a profitable, closely held company. Most of the remainder are used either as a supplemental employee benefit plan or as a means to borrow money in a tax-favored manner. Less than 10% of plans are in public companies. In contrast, stock option or other equity compensation plans are used primarily in public firms as an employee benefit and in rapidly growing private companies.

Companies set up a trust fund for employees and contribute either cash to buy company stock, contribute shares directly to the plan, or have the plan borrow money to buy shares. If the plan borrows money, the company makes contributions to the plan to enable it to repay the loan. Contributions to the plan are tax-deductible. Employees pay no tax on the contributions until they receive the stock when they leave or retire. They then either sell it on the market or back to the company. Provided that an ESOP owns 30% or more of company stock and the company is a C corporation, owners of a private firm selling to an ESOP can defer taxation on their gains by reinvesting in securities of other companies. S corporations can have ESOPs as well. Earnings attributable to the ESOP's ownership share in S corporations are not taxable.