United States Individual Tax Site: Employee Stock Option Plans

Introduction A summary of the range of schemes available in the US.

Employee Stock Option Plans There are numerous advantages for employees, companies, and existing shareholders when implementing an ESOP.

Profit Sharing Plans And Eligible Individual Account Plans (EIAP) An EIAP is a form of profit sharing plan which can be designed to permit up to 100% of trust assets to be invested in employer securities.

401(K) Plans A 401(k) plan permits employees to choose to defer a portion of their wages on a pre-tax basis.

Broad Stock Options: Incentive Options With an incentive stock option, a company grants the employee an option to purchase stock at some time in the future at a specified price.

Employee Stock Purchase Plans The purchase plan option gives employees an opportunity to share in the growth potential of the company's stock.

Unqualified Broad Stock Options The purchase plan option gives employees an opportunity to share in the growth potential of the company's stock.

Recent Legislative Developments The Treasury's rulings from 2004 to 2009, and legislative efforts in Congress.

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 US 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 US 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 tens of thousands of ESOPs in the US covering millions of participants and controlling hundreds of billions of dollars in company stock.

Most public companies maintain an ESOP along with other benefit plans.

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.