Definition
The term employee stock ownership plan refers to a company-sponsored benefit program that provides employees with an ownership interest in their company. Participating in an employee stock ownership plan is one of several ways employees can purchase shares of common stock in their companies.
Explanation
Employees can share in the ownership of their company through an employee stock ownership plan, or ESOP. These plans provide employees with shares of common stock that are held in trust until the employee leaves the company. ESOPs are not the same as employee stock purchase plans. Employees participating in a purchase plan typically acquire shares of common stock at a discount.
With an employee stock ownership plan, the company allocates shares of common stock on behalf of an employee into a trust. The number of shares allocated is usually a function of the employee's years of service and / or base pay. Shares held on behalf of the employees will be 100% vested in no more than six years. Companies have the option of contributing new shares directly into the fund or providing the cash to purchase existing shares on the market. In either scenario, all company contributions are tax-deductible.
The shares are held in this trust until the employee retires, or otherwise leaves the company. At that point, the company will either buy back the stock, or the employee can sell the shares on the open market. Employees do not pay federal income taxes on contributions to the ESOP; however, cash distributions are taxable, including any capital gains. Employees also have the option of rolling over their distribution into a retirement plan.
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