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Employee Stock Ownership Plans
An
ESOP is a type of qualified retirement plan
governed by the Employment Retirement Income
Security Act of 1974, as amended (ERISA), and
the Internal Revenue Code of 1986, as amended
(the "Code"). There are numerous advantages
for employees, companies, and existing shareholders
when implementing an ESOP. ESOPs, however, have
some limitations. For example, because ESOPs
are tax qualified plans, they must meet numerous
coverage, nondiscrimination, distribution, and
other requirements of the Code. Furthermore,
it is impossible to tailor ESOPs to benefit
only a particular group of highly compensated
employees. Finally, the Code's distribution
requirements prevent employees from receiving
any immediate benefits from the appreciation
of the stock held by an ESOP because distributions
from tax qualified plans generally cannot be
made until retirement, disability, death, or
other termination of employment.
A
unique feature of U.S. employee ownership law
is the leveraged ESOP. It allows employees to
purchase shares on credit, using the credit
capacity of the company itself to secure the
loan, which is then repaid out of future corporate
cash flows. This enables employees to obtain
larger blocks of shares than they would otherwise
be able to purchase on their own and has resulted
in ESOPs playing a significant role in corporate
restructuring and ownership transition strategies.
To encourage the growth of ESOPs, the U.S. Congress
has granted ESOPs important tax advantages.
These include a corporate tax deduction for
the principal and interest payments on ESOP
loans; a corporate tax deduction for dividends
paid on ESOP shares; and a deferral of capital
gains taxes for individuals selling shares to
an ESOP in a non-publicly-traded company (if
the ESOP ends up with a minimum of 30% of the
shares).
There
are currently over 10,000 ESOPs in the U.S.
covering almost 9 million participants and controlling
over $210 billion in company stock. Of these,
about 15% are in publicly traded companies and
85% in closely held companies. The median percentage
ownership for ESOPs in public companies is about
10 to 15%. Most public companies maintain an
ESOP along with other benefit plans. The median
percentage ownership for private companies is
about 30 to 40%, with about 2,500 companies
now majority employee owned. About half the
ESOPs in private companies are used to buy out
an owner; the rest are typically used as a primary
employee benefit plan, sometimes in conjunction
with borrowing money for capital acquisition.
Other
types of qualified retirement plans, such as
eligible individual account plans (EIAPs), can
be used to meet many of the same objectives
that ESOPs are often used to achieve, including
diversification of shareholders' assets, creation
of capital for the company and providing equity
incentives for employees.
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