ESOPs, or employee stock ownership plans, provide employees with a share of the company. While ESOPs have many advantages, there are drawbacks and tax implications to consider.

Drawbacks of ESOPs

Like most of the financial market, ESOPs can struggle in bear markets. Employees' accounts may suffer in this period. 

ESOPs may also lack diversification. Being invested in a single company's stock can be a gamble. Diversification is especially important for retirement accounts to minimize the risk of one down stock destroying someone's life savings.

Privately held companies can also accrue significant costs with an ESOP. The specialized nature of an ESOP can be an advantage, but it also comes with significant costs.

Running an ESOP requires administrative costs and other overhead. By one measure, an ESOP should have, either on staff or freelance, an accountant, a lawyer, a trustee, and several advisors. There are also compliance considerations to address.

ESOPs cannot pay more than fair market value for the stock. This can be lower than what an individual could obtain on the open market. 

Tax Penalties

Depending on the plan, when a fully-vested worker leaves the company, the company buys back the shares. The company then pays the worker in either a lump-sum payment or periodically. This doesn't mean, however, that any worker who leaves the company or retires can automatically access their shares.

On the flip side, taxpayers can be penalized for overly delaying withdrawing from an account. Taxpayers should check with their laws to see if and when they need to begin drawing from the account. 

ESOPs are generally tax-deferred, meaning a taxpayer isn't required to pay taxes until they cash out the ESOP. Early distribution from retirement accounts can result in a 10 percent tax penalty. In general, individuals must wait until they are 59 ½ to begin drawing from an ESOP. 

If you need help with ESOPs, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.