An ESOP stands for employee stock ownership plan. One of several forms of employee ownership, ESOPs give employees a share of a company in the form of stock. A tax-deferred retirement plan, ESOPs have tax benefits and are also believed to be beneficial for increasing worker connection and satisfaction.

What is an ESOP?

The IRS defines an ESOP as a qualified defined contribution plan. ESOPs must be organized in a way that they invest primarily in qualifying employer securities, and they've been compared to profit-sharing plans.

ESOPs must meet certain IRS requirements. The IRS and Department of Labor share jurisdiction over ESOPs. 

Employees can join ESOPs in different ways, depending on how a company organizes its operations. Some may receive stock for certain milestones with a company, such as the number of years employed. Others may allow employees to make direct purchases from the company. 

Benefits of ESOPs

By making employees shareholders in the company, ESOPs give workers an incentive beyond just getting a paycheck. They have a stake in the company's performance and its future. 

ESOPs have been found to help increase workers' incentives to do what's best for the company and the shareholders because the employees are also shareholders. While employees often have to wait years for ESOPs to vest, they do tend to gain more stock the longer their tenure lasts.

Unlike 401(k)s or IRAs, ESOPs are company-funded rather than employee-funded. For corporations organized as S-Corps, the ESOP's share of recognized earnings is often exempt from income taxes.

Both companies and legacy owners tend to benefit from an ESOP. C-Corps can also potentially benefit from an ESOP. 

ESOPs allow for more personalization and specialization compared to an external employee plan. By tailoring an ESOP to what makes a company unique, employees and shareholders can benefit from a more bespoke approach to managing the ESOP. 

ESOPS also score high on confidentiality. They generally don't share employee or shareholder information.

ESOPs have benefits for employees and owners, but they aren't perfect. In the next post, we'll look at the drawbacks and tax implications of ESOPs.