The basics of an ESOP

By Steve Savant

Ash Brokerage Corporation

The employee stock ownership plan (ESOP) is essentially a stock bonus plan in which employer stock may be used for contributions. The plan must pass certain voting rights through to the participants. If the stock is not publicly traded or is restricted, the participant or his or her heirs must have the right to offer the stock for sale to the employer.

The plan may borrow money from a bank to purchase stock, with the employer guaranteeing such a loan, without it being considered a prohibited transaction. The plan may borrow money from a prohibited person without incurring any penalty. The plan may not be integrated with Social Security. Whereas a stock bonus plan is not required to invest in employer securities, an ESOP must invest primarily in employer securities, to the extent that employer stock is available. The employer can contribute company stock directly to the plan (however, it may be better to contribute cash and then have the plan purchase stock from the employer).

The valuation of stock directly contributed to the plan may be challenged by the IRS. Contributing cash clearly establishes the value of the contribution. The plan may purchase the securities on the open market for public companies, from the company itself or from the shareholders. The employer can contribute and deduct up to 25 percent of compensation for a leveraged ESOP, which is repaying the loan principal. In addition, it can make deductible contributions to pay interest on the loan used to purchase securities. Steve and Keriti discuss the basics of ESOPs for business succession planning.