ESOP ( Employee Stock Ownership Plans ) Ι Rules & Types of ESOP.
Explanation of ESOP
An ESOP is a kind of employee benefit plan, similar in some ways to a profit-sharing plan. In an ESOP, a company sets up a trust fund, into which it contributes new shares of its own stock or cash to buy existing shares. Alternatively, the ESOP can borrow money to buy new or existing shares, with the company making cash contributions to the plan to enable it to repay the loan.
Rules of ESOP
1. Vesting: Before an employee acquires entitlement to ESOP, he must work for a certain period, which is referred to as the vesting period. If an employee leaves before vesting, he loses the right.
An ESOP must comply with minimum schedules for vesting, called cliff vesting or graded vesting. In cliff vesting, the first three years do not require vesting. There is 100% vesting after three years of service.
2. Distributions after termination: Distribution of vested benefits with retirement, disability or death, takes places during the following plan year.
3. Distribution during employment: Cash or stock can be received directly by employees by diversifying their accounts. Dividends may be paid by the employer to a participant who is at least a 5% owner beyond the age of 70, although still working in the company.
4. Put Option: A put option is offered by some companies, for company stock bought via the ESOP benefits plan. In this option, the employee can sell their company stock back to the employer within 60 days after distribution and within 60 days during the following plan year.
5. Taxation: No tax is required to be paid by the employees on the stock until they receive distributions. Payments are subject to applicable taxes, and an additional 10% excise tax will be levied. Dividends that have to be paid directly to participants on stock are taxable.
Types of ESOP
1. Non-leveraged ESOPs: A non-leveraged ESOP is a stock bonus plan, identified as an ESOP in the plan document that invests primarily in company stock and meets certain legal requirements.
2. Leveraged ESOPs: A leveraged ESOP borrows money on the credit of the employer or other related parties to buy company stock. It is only a qualified employee benefit plan that can do this. The loan can be towards the ESOP itself or to the employer who then lends the money to the ESOP.