What Is an ESOP?

First and foremost, an ESOP is an employee benefit plan that is qualified for tax-favored treatment under the Internal Revenue Code of 1986, as amended (IRC). However, an ESOP can also be a tool of corporate finance, and provide a market for closely held stock. For ESOPs sponsored by S corporations under IRC Section 1361, the ESOP may also offer significant tax savings.

Unlike other retirement plans, an ESOP is mandated by law to invest its assets primarily in stock of the sponsoring company. It is also the only ERISA-qualified plan that is permitted to borrow funds on company credit in order to acquire company stock. In addition, shareholders who sell company stock to an ESOP are permitted, in certain circumstances, to defer taxation on the gains realized from the sale. For all of these reasons and more, an ESOP can be a powerful tool in business planning.

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