An employee stock ownership plan, or ESOP, is a type of defined contribution retirement plan in which employees’ accounts are invested primarily in stock of the sponsoring employer. In other words, the ESOP literally owns the corporation — whether partly or fully — allowing the employees to benefit from its success.
ESOPs are unique retirement vehicles. They can serve several purposes in addition to providing retirement benefits, such as:
- Creating a marketplace for the stock of a closely held corporation;
- Realizing certain tax advantages, such as allowing the owner of a C-corporation to defer tax on the proceeds from the sale of his or her stock to the ESOP (through 26 U.S.C. § 1042), or allowing S-corporations to avoid federal (and sometimes state) income tax on their share of a company’s profits;
- Improving employee productivity and corporate culture; and
- Allowing a business owner to gradually sell a company without having to close the business or terminate its employees.
According to the National Center for Employee Ownership, there are nearly 6,800 ESOPs nationwide, with about 13.9 million participants holding assets of more than $1.2 trillion. This includes 401(k) plans in which the employer’s matching contribution is provided through company stock (sometimes called a KSOP).
ESOPs are not right for every company, however. Factors that should be considered are the size of the company, the type of corporation, the potential tax advantages, the owner’s motivations and expectations, the availability of replacement management if and when the owner departs, and the ability to foster a positive corporate culture around employee ownership. In addition, both the creation and ongoing administration of an ESOP are subject to substantial regulation.