Employer contributions are allocated to individual employee accounts according to a specified formula. These contributions are tax deductible to the employer within certain limits. To qualify for deductions, an ESOP must be in writing and the sponsoring employer must establish a trust for employer contributions. Furthermore, the plan must have fiduciaries who are responsible for setting up and maintaining separate employee accounts. When properly established and maintained, the trust incurs no current income tax liability and plan participants are not taxed on ESOP income until distributions are received.
Taxation is based upon increases in the value of the stock.
The ESOP vesting schedule must specify the percentage of assets each participant will earn upon completion of periods of service or plan participation, and the vested portion of the participant's assets must be distributed as outlined in the trust document. A Viable Option ESOPs are certainly not for all companies, although the wide range of ESOP applications to fill company needs makes them a viable option for many. To promote the concept of employee stock ownership, Congress has granted a number of tax incentives to employers adopting ESOPs. Specific advantages include deductible ESOP contributions and dividends, lender incentives to provide low interest loans, tax-advantaged rollovers for owners selling stock to employees, and estate tax advantages. When considering ESOPs, business owners must thoroughly analyze the potential drawbacks.