Purchasing stock, participating in available profit sharing programs, joining worker cooperatives and receiving bonuses are all ways in which employees can become owners. While all of these methods are beneficial, they are not as common as employee stock ownership plans (ESOPs). If you have heard of ESOPs, it might have been in light of controversies surrounding how they’re used by employers.
As it turns out, much of the excitement about employer use of ESOPs is ill-informed because they are exceptionally beneficial to employees. In fact, most employees don’t even purchase the stock. Instead, it’s contributed to them by the employer. Let’s delve a little deeper into this method of employee stock ownership, which might explain some of the reasons why they have become increasingly popular since around 1974.
You might be surprised to know that there are thousands of ESOPs available. Participation in these plans has been steadily expanding for decades, reaching beyond 14 million people. One of the reasons why there has been controversy is because there was a sense that ESOPs are used by employers for the primary purpose of having a financial vehicle to use if the company falls on hard times. While there are instances where this happens legitimately, and in alignment with regulated ESOP uses, it is not at all common.
The fact that ESOPs are used to reward employees and there are limitations to how an employer can use them is compelling. It’s also partially why so many employees participate in these plans. From a practical standpoint, ESOPs are beneficial because they provide employers with a market for shares when an owner leaves a company. This is just one of multiple ways in which ESOPs accommodate a functional requirement, which is beneficial to employees.
Allowable ESOP Uses
In addition to buying shares when an owner departs, companies can use ESOPs for the purpose of creating another employee benefit. They do this by issuing treasury shares to an ESOP and deducting the value for taxable income. They can also issue new shares or contribute cash, which involves buying shares from current owners, either private or public. It’s common for employers to use ESOPs in conjunction with other offerings, such as employee savings plans (ESPs) that have an employer match. Instead of an ESP, the employer matches stock from the ESOP at a level that’s higher and more beneficial to the employee.
What makes an ESOP unique is that it allows employers to actually borrow money, which is one of the elements that has raised questions in the past. Essentially, the ESOP will borrow money and buy shares. The loan is repaid with contributions made by the company. In addition to the obvious benefit of having access to cash, the contributions made by the company are tax deductible.
Other Tax Considerations
There happen to be major tax benefits associated with ESOPs. As aforementioned, stock contributions are tax deductible, which give companies the advantage of cash flow. It’s worth noting that cash contributions are also tax deductible. This usually involves a company contributing cash and taking a tax deduction for what has been contributed, which can be used to build a cash reserve or buy shares. Additionally, ESOP dividends are tax deductible and employees do not have to pay taxes on contributions.
While there are clear benefits associated with ESOPs that can positively impact companies and their employees, there are also limitations which are outlined in tax and retirement plan laws. The bottom line is that ESOPs can be a win-win solution for companies and employees, which is why they will continue to grow in popularity.