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Annotated diagram of Schedule DTax errors can be costly! Don't draw unwanted attention from the IRS. Our Tax Center explains and illustrates the tax rules for sales of company stock, W-2s, withholding, estimated taxes, AMT, and more.

Life Events: Retirement Plans

What is an employee stock ownership plan?

An employee stock ownership plan (ESOP) is a tax-qualified retirement plan designed to invest primarily in the voting stock of the employer. The contribution to the plan, whether company stock or cash used to buy company stock, is immediately deductible, subject to certain limits, by the employer. The ESOP can also borrow money, with a company guarantee, to buy stock in the sponsoring company. Employees do not pay taxes on amounts received (i.e. allocated to their accounts) until plan benefits are actually paid, usually at termination of employment or later. In some instances, the participants who receive distributions in the form of stock may defer taxation of the appreciation on the stock.

To satisfy the tax rules of retirement plans, ESOPs must cover a broad range of employees, adhere to vesting schedules no less favorable than those provided by law, and allocate benefits on a substantially uniform basis (e.g. as a percentage of W-2 compensation for the year). ESOPs are used principally by entities with regular cash flow that need tax deductions. The National Center for Employee Ownership (NCEO) has extensive resources and seminars on ESOPs. The sellers of stock to an ESOP may also defer capital gains taxes on the sale when certain conditions are met for a rollover under Internal Revenue Code Section 1042.

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