What Is an Employee Stock Ownership Plan?

An employee stock ownership plan (ESOP) is an employee benefit plan that allocates company stock to employees. By receiving company shares, employees gain partial ownership of the company they work for, including voting rights.

All employees age 21 and over who work 1,000 hours or more in a year must be included in the plan. Typically, the longer an employee works for a company, the more shares he or she is eligible to receive. Employees must be entitled to full ownership of the shares after working for the company for a set time (known as the vesting period).

Once an employee is fully vested in the plan, he or she owns the shares unconditionally. Employees must be 100 percent vested within five to seven years of service. After employees leave the company or retire, they receive their stock and can sell it back to the company for fair market value if they choose.

In an ESOP, a company sets up a trust fund and then contributes shares or cash to buy shares for the fund. In a trust fund, financial control of the fund's assets is in the hands of an outside trustee. The company can borrow money to buy more shares, paying the loan back with contributions to the trust. As the loan is paid back, shares are allocated to employee accounts from the trust.

ESOPs are known as qualified stock plans because they meet Internal Revenue Service requirements to receive favorable tax treatment. Company contributions to the ESOP fund are tax-deductible within certain limits. Companies offering ESOPs must abide by federal rules preventing favoritism toward higher-paid employees. Non-qualified plans do not receive favorable tax treatment and include broad stock option plans based on a percentage of pay or merit formula.

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