ESOP is an acronym. It stands for employee stock ownership plan. Technically, ESOP plans are operated, and administered, pursuant to a tax-exempt trust, referred to as an ESOT – known as employee stock ownership trust. The plan is referred to as the ESOP or ESOT.
The purpose of an ESOP is to allow employees to acquire and ownership in the company without having to invest their own money. The plan is a tax exempt entity for federal and state corporate income tax purposes. It allows the company to make cash/company stock contributions to the Trust, which are then used to acquire stock of the company on behalf of its employees. The advantage of an ESOP is that employees can acquire the stock without paying a current income tax on the stock. It results from the fact the contribution is made from the company, and isn’t taxed to employees personally. The advantage of the ESOP is that employees can use Pre-Tax dollars to finance the company, and purchase shares. It helps business owners finance the company, and create ownership liquidity.
Because employees aren’t taxed currently on the stock which is acquired for them – they are able to get twice the amount they could normally get if a trust arrangement wasn’t used. If an employee gets stock directly from the company, or other shareholders, then the employee uses after-tax funds rather than pre-tax dollars. By using a trust, it eliminates a tax problem since the trust isn’t taxable and frees employees from income tax liability issues until the shares are distributed.