Employee Stock Ownership Plan: All About Tax Matters

Employee Stock Ownership Plan

An ESOP or Employee Stock Ownership Plan is basically a retirement plan that’s tax-qualified and provides ownership interest for employees. More specifically, it is a retirement plan for stock bonus that employers fund or finance for their employees. ESOPs benefit both employees and employers.

But if you’re looking to form one, there are specific tax consequences and rules you need to understand to ensure accurate planning for taxation.

ESOP Tax Implications for Employees

  • ESOP beneficiaries will be taxed in the specific year that benefits are made available or allocated to them.
  • Distributions from ESOPs can be distributed in yearly or regular installment payments or a lump sum. Installment payment should be completed not more than five years.
  • ESOP distributions will be considered taxable income. However, if they obtained theirs in lump sum stock, they would need to pay tax on the rate of their employer’s plan contributions, as well as capital gains if the stock is sold and its value appreciates.
  • Employees won’t be taxed early distribution tax on ESOP dividend distributions, even if they get them before turning 59.5 years old.
  • According to IRC, Internal Revenue Code rules, employees are allowed an ESOP eligible rollover distribution that’s tax-free. If employees made the rollover within 60 days of contributing to the ESOP, the rolled-over amounts would not be taxed. Employees have the option of rolling over their distributions to their individual retirement annuity, IRA or individual retirement account, or other employer-approved plans.

ESOP Tax Implications for Employers

  • Through ESOP contributions, employers are provided tax deductions and advantageous tax treatment regarding specific transactions related to stocks.
  • ESOP employer contributions can be deducted in the specific year they contributed to the plan. Contributions could consist of stock from the employer’s corporation or cash. For stock contributions, employers will not recognize any losses or gains on taxes.
  • The tax-deductible ESOP contribution of employers has a limit of 25% of the owed or paid compensation in the specific tax year to beneficiaries of the plan. If employer contributions are higher than this limit, employers can carry the excess to the subsequent tax years.
  • Employers are likewise allowed extra deductions for all dividends paid on the stocks of employers that are kept in a plan. Also, C corporations are provided deductions for all qualified dividends that were paid in actual cash. Extra rules will apply to dividend deductions on stocks.
  • If the ESOP contributions of employers were utilized for paying interest on a leveraged ESOP loan, there’s no limit to the deduction. This is basically a type of loan that borrowed funds to purchase eligible employer stock. Take note that the deduction will only apply if the interest is from the leveraged ESOP loan used for buying employer stocks.


As you’ve probably gleaned from above, developing an ESOP could be quite complicated and potentially costly to maintain. On the other hand, it could offer employers and employees favorable tax consequences and thus deserve to be considered when planning employee benefits.

Speak to your lawyer to help you make the right choice.

About the Author

Scroll to Top