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ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
What is it?
• A stock bonus plan is defined contribution plan similar
to a profit sharing plan, except that accounts are
invested in employer stock
• An ESOP is a stock bonus plan that the employer
can use as a conduit for borrowing money from a
bank
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
What is it indicated?
• When an employer wants to provide a tax
advantages way for employees to acquire company
stock at a low cost to itself
• When shareholders would benefit from the additional
market for company stock created by such plans
• When an employer is looking for an advantageous
vehicle for borrowing money for business needs
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Advantages
• Employees receive an ownership interest in the
employee company
• Provides performance incentive for employees
• Market is created for employer stock, increasing
liquidity for existing shareholders
• Employees are not taxed until the shares are
distributed
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Advantages
• Taxation of “unrealized appreciation” can generally be
deferred until shares are sold by the employee
• Employer receives a deduction for the contribution of
cash or shares of stock
• Overall cost of corporate borrowing can be reduced
• Shareholders can obtain tax benefits by selling stock
to the plan
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Disadvantages
• Since the plan is qualified, all the qualified plan
requirements apply
• Issuing shares of stock to employees “dilutes” the
stock of existing shareholders and their control of the
company
• Company stock may be a very speculative
investment!
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Design Features
• Participants’ accounts are stated in terms of shares of
company stock
• Benefits generally distributed in the form of shares of
company stock
• Dividends can be used to increase participants’
accounts or in cash
• Plan allocation formulas may not discriminate in favor
of highly compensated employees
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Design Features
• Plan participants must be given certain voting rights
depending on whether the stock is publicly traded or
not
• Participants may demand that distributions be made
in company stock
• Employer may be required to repurchase company
stock that is not traded on an established market
(called a “put option”)
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Design Features
• Stock valuations used for all plan purposes must be
made by an independent appraiser
• ESOPs only – participants who have reached age 55
and have at least ten years of participation must be
allowed an annual election to diversify investments in
their accounts
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Design Features
• Stock valuations used for all plan purposes must be
made by an independent appraiser
• ESOPs only – participants who have reached age 55
and have at least ten years of participation must be
allowed an annual election to diversify investments in
their accounts
• ESOPs only – “leveraging” features allow employer to
borrow money on a favorable basis
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Tax Implications
• Employer contributions deductible when made
– Annual deduction for stock bonus or S corp ESOP is limited
to 25% of payroll of covered employees
– Annual deduction for C corp ESOP is up to 25% of covered
payroll for amounts used to repay loan principal and no limit
on amounts used to pay interest
• Section 415 limit on annual additions applies to stock
bonus plans and S corp ESOPs
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Tax Implications
• C corp ESOPs have higher Section 415 limit in that
employer contributions applied by the plan to the
payment of interest on certain loans incurred to
acquire company stock are not included
• Within certain limits, C corporations can deduct
dividends paid on stock acquired with an ESOP loan
• Taxation of employee is deferred
• Special 10-year averaging may apply for lump sum
distributions to certain employees born before 1936
Copyright 2009, The National Underwriter Company
ESOP/Stock Bonus Plan
Chapter 18
Employee Benefit & Retirement Planning
Tax Implications
• Additional benefit of stock bonus/ESOP plans – tax
on unrealized appreciation of stock received in a
lump sum distribution may be deferred until the
employee sells the stock
• Shareholders of nonpublicly traded C corporations
may not have to recognize gain for income tax
purposes when they sell shares to an ESOP under
certain conditions
Copyright 2009, The National Underwriter Company