ESOP

• Outside the U.S., the term ESOP has a variety of meanings. It can be a generic term for employee ownership of any sort. Also, again outside the US, the same acronym is employed to refer to Employee Stock Option Plans.
  
  However, in the U.S. the term is quite specific and tied to the Internal Revenue Code sections 409 and 1042. An ESOP is a plan in which a qualified company contributes some of its own stock (and generally cash) into a trust, receives a tax deduction based on the value of that contribution and deducts from its taxes the dividends it pays on the contributed shares.
  
  

Qualifications

• IRC section 409 sets out many qualifications for an ESOP. A participating company must give each participating employee a non-forfeitable right to any employer security allocated to his 409(c) account, generally due upon retirement.
  
  The section contemplates the possibility that some companies with ESOPs will not be able to make distribution of plan benefits in the form of employer stock, when that stock is "not readily tradeable on an established market." In such a case, the beneficiary has a right "to require that the employer repurchase employer securities under a fair valuation formula."
  
  

Expert Insight

• ESOPs can involve considerable administrative costs and difficulties. Further, the originating documents must be drafted with care. The law firm Chang Ruthenberg & Long cautions on its website that there are boilerplate documents available, but these "will cause problems if they are not carefully tailored, amended and edited" to the needs of a particular company.
  
  

ESPP

• In an ESPP, the employee contributes to a plan by payroll deductions. These deductions accumulate throughout an offering period, which may last anywhere between three and 27 months.
  
  There is generally a discount (of up to 15 percent) between the full market price of an employer stock and the price at which it is offered through the ESPP. Often employees can buy stock at the set discount from either the beginning or the end of the offering period, whichever is lower.
  
  

Section 423

• Companies set up an ESPP under IRC section 423. This requires that the issuing company's stockholders approve of the plan within 12 months before or after the date it is adopted; that the plan shall not be a vehicle by which any employee shall acquire 5 percent or more of the total combined voting power of the corporation; and that the plan will be available to all employees who have been employed for 2 years or more, who work more than 20 hours each week and who work for at least 5 months in any calender year, except for certain highly compensated employees.