Information and Frequently Asked Questions
for Employee Stock Ownership Plan (ESOP) Participants
An Opportunity to Take Part in Your
Company's Success
If you’ve been invited to participate in your
company’s Employee Stock Ownership Plan
(ESOP), congratulations. An ESOP is an
opportunity to take part in the growth potential of
your company. As an ESOP participant, you may
play a greater role in your company’s operations.
For one, an ESOP account gives you a window into
the financial performance of your company.
Furthermore, you may be invited to participate in
committee work in support of your ESOP. We
encourage you to take advantage of this
opportunity. After all, there’s nothing like the
feeling of helping to control your company’s
future--and your own.
interest of participants and not directly by the participants. What is an SPD?
A summary plan description (SPD) is a plain
English summary of the major provisions of a
retirement plan document. Every participant is
entitled to a copy and should read it.
Participating in an ESOP
There is much that you can do as a participant in an
ESOP that will make a difference for your
company, for yourself and for fellow employees.
Committees
If you have the opportunity, join the ESOP
committee. Participate in committee activities. Set
An Employee Stock Ownership Plan (ESOP) is a an example for other employees. You can make a
qualified, tax‐deferred retirement program created difference.
under the Employees Retirement Income Security Relative performance
Act of 1974 (ERISA). An ESOP provides a vehicle Quarterly measures of performance have been
for sharing company ownership with employees. An ESOP can be created only by an employer, and maintained and compared for 10 years for smaller
the employer is the plan sponsor. The employer can companies. ESOP companies often perform better
that their non-ESOP competitors.
use the ESOP to acquire ownership from a prior owner or can contribute shares to an ESOP in order Representation
to give a portion of company ownership to The ESOP Association and the National Center for
participants. In either case, the shares of company Employee Ownership each hold periodic
stock are placed in a trust that is the responsibility conventions and seminars at different locations
of a trustee. The shares of company stock in an around the country. Volunteer to represent your
company at one or more of these meetings. You
ESOP are owned by the trust for the beneficial What is an ESOP?
CHICAGO
NEW YORK
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www.greatbanctrust.com
GREATBANC TRUST COMPANY IS A SUBSIDIARY OF U.S. FIDUCIARY SERVICES, INC., AN EMPLOYEE-OWNED COMPANY.
will learn from the experience and others will learn entitled to direct the trustee on how to vote the
from your participation.
shares that are allocated to them. This is called
pass-through voting because the shareholder vote
Be creative
is “passed-through” to participants and they are
There are many ways to create and maintain
entitled to direct the trustee on how to vote the
enthusiasm for an ESOP within a company. You
shares allocated to them. Some ESOP plan
can volunteer to be a part of making the ESOP a
documents give this opportunity to participants for
success at your company.
all shareholder votes. At the minimum, participants
are allowed to direct the trustee on major corporate
Participant Rights
events such as a merger or other major financial
The following is a brief summary of your general
restructuring.
rights under an ESOP. For additional details on
Employment Termination
these and other rights, please refer to your
Summary Plan Document (SPD), which is available If your employment is terminated while you are a
from your employer.
participant in an ESOP, you may face specific
choices regarding your plan assets. Many of these
Rights regarding share distributions
choices depend on the wording of the plan
When you qualify for a distribution from the plan
document. Please consult your Summary Plan
and your company is a C Corp, you have the right Description (SPD).
(with some exceptions) to receive shares of
Vesting
company stock from the plan.
The vesting in your account immediately freezes
There are potential tax benefits to receiving and
upon employment termination. You should consult
holding shares of stock instead of receiving a cash
distribution. If your company is closely held, there the SPD for the date when vesting becomes
effective. It is often the last day of the plan year. If
may be agreements that limit who can own
company stock. In this case you may be required to this is the case and your employment is terminated
immediately sell your shares back to the company at any time prior to this date, your vesting stays at
the prior year’s level.
or the ESOP.
Rights regarding diversification
Distribution restrictions
At age 55, if you have been a participant for more
than ten (10) years, you may be entitled to diversify
some of your ESOP account out of company stock
and into other investments. There are specific rules
regarding the time period in which you may
diversify, and the diversification options available.
For details, please refer to your SPD.
If your company’s ESOP is leveraged, there are
often provisions in the plan document that prohibit
or restrict distributions until the loans are paid off.
You may be required to leave your vested shares
with the company until these restrictions are
removed. This can often be for five years or more
after the initial loan. Sometimes, employers will
want to convert your shares to a note but still not
distribute money to you until the loan restrictions
are removed. In this case, they must have adequate
collateral for that note.
Rights regarding the voting of shares
The shares of company stock in your company’s
ESOP are actually owned by the ESOP trust.
Therefore, you do not have the right to vote
directly. In some cases, however, participants are
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Distribution options
examine the provisions of the termination. When a
plan is terminated, all participants immediately
become fully vested in all balances that have been
allocated to their accounts.
Once any restrictions have been removed and you
wish to take a distribution, you have the following
options:
•
•
•
•
If the ESOP is being terminated as the result of a
sale or merger of the sponsoring company, then the
ESOP trustee still has an obligation to follow the
provisions of the plan document and assure that
Roll the shares or money over directly into an the trust is receiving adequate consideration in
individual retirement account (IRA).
return for the shares it holds.
Sell the shares to the company and roll the
money over into a qualified plan of your next
employer, if the new plan accepts rollovers.
Sell the shares to the company and request a
check written directly to you. In this case, the
amount distributed is fully taxable. The
administrator will withhold 20% of the
amount distributed. In addition, you will owe
a 10% penalty on the amount when you file
your tax return if you are under age 59½.
Termination of a plan is a “distributable event”
under the 1974 Employee Retirement Income
Security Act (ERISA), and participants may elect to
receive cash directly or to roll their accounts over
into an IRA or a successor 401(k) plan.
Removing Assets
Due to potential tax consequences, you should
carefully weigh the alternatives before removing
assets from an ESOP. Consult your tax advisor for
guidance on the approach that’s appropriate for
you.
Request that the shares of company stock in
your account be re-registered in your name
and given to you. While nothing will be
withheld, you will still owe taxes on the cost
value of those shares and there will be a 10%
penalty on that amount when you file your
tax return if you are under age 59½. Many
closely-held companies will not allow a
terminated participant to hold shares and will
require you to sell them to the company at the
price established at the last valuation.
The rules for removing assets from an ESOP vary,
depending on whether the assets consist of
company stock or other investments. Here are
some of the major factors to consider for each type
of asset:
For ESOP assets in company stock
Plan Termination
Company stock receives special tax treatment for
individuals. For example, when you remove shares
of company stock from your plan, they are taxed at
ordinary income tax rates only to the extent of the
original cost of the shares. The full amount of the
gain in excess of original cost will be taxed at
capital gains rates when you actually sell the
shares.
The decision to terminate an ESOP is the right of
the plan sponsor. There are several reasons to
terminate an ESOP, such as:
•
The sale or merger of the sponsoring
company
•
The liquidation of all ESOP debt
•
The bankruptcy of the sponsoring company
Two strategies you may want to consider when
removing company stock are:
When a plan is terminated, the employer/plan
sponsor will normally file a form 5310 with the IRS.
This gives notice to the IRS and allows them to
•
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IRA strategy: Rolling shares of company stock
over into an IRA can have adverse tax
to acquire shares of the employer’s stock to hold for
the benefit of participants in the retirement plan
and the loan(s) are still outstanding. Once the
loan(s) are paid off, the ESOP is no longer
leveraged.
consequences, because it negates the special
tax treatment available to company stock.
You may find it a better tax strategy to take
the distribution in shares, pay taxes
immediately on the cost of the company
stock, and then hold the shares outside of
your IRA, 401(k) or other qualified plan. This
strategy may enable you to pay taxes on any
gains at the lower capital gain rates instead of
the normally higher ordinary income tax
rates.
•
What is a Leveraged ESOP?
Many ESOPs are leveraged, meaning that the trust
has borrowed money to purchase the shares of
company stock that are now held in the trust. Many
special rules apply to leveraged ESOPs. For
example, the sponsoring company is required to
make regular payments (contributions) to the trust
in order for the trust to make its required payments
of principal and interest on the loan. Because the
ESOP is a qualified retirement program, the
payments made by the employer into the trust are
fully tax deductible.
Estate strategy: Generally, shares of company
stock enter one’s estate at the “stepped-up”
basis, which would potentially result in
significant tax savings.
For ESOP assets other than company stock
The regular deferrals you make into an ESOP or
401(k) Plan are tax-deferred, as are employer
contributions and any earnings on your
investments. When you start to take distributions
from your plan, these cash distributions are all
taxed at ordinary income tax rates.
What Happens to Shares in a Leveraged
ESOP?
Usually when an ESOP is leveraged, some of the
shares of company stock held in the trust are
collateral for the ESOP loan. As loan amortization
Two strategies you may want to consider when
payments are made, shares must be released from
removing non-company stock assets are:
collateral. When they are released, they can then be
allocated to individual participants in the plan.
• IRA strategy: Rolling distributions over from
Usually the shares of company stock are allocated
investments other than company stock into an
to participant's accounts at the end of each plan
IRA can be a valuable strategy. It may help
year. If loan payments are made more frequently
you avoid mandatory withholding while
during the year, then some shares are held in
allowing your assets to grow on a taxreserve. This means that some shares of company
deferred basis until withdrawals are made
stock are no longer available as collateral against
after retirement.
the loan but have not yet been allocated to
• Estate strategy: All assets of an IRA or other
individual participant accounts.
qualified retirement plan go to the designated
How are Shares in an ESOP Valued?
beneficiary/ies. The estate steps up the tax
If the sponsoring company is publicly held, the
basis of the assets to the market value at the
value of the shares is established every day by the
date of transfer to the beneficiary/ies.
stock market. If the company is private, the shares
What is Leverage?
of stock held in the trust must be valued at least
Leverage refers to borrowing. A leveraged ESOP is once per year. An independent appraiser is hired
one where the trust has borrowed money in order
by and reports to the trustee for this purpose.
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What Keeps an S Corp from Converting to a Why Can't I Get My Money or Shares out of
C Corp to Take Full Advantage of the ESOP My ESOP any Time I Want?
Roll Over Feature?
Because it is a type of retirement plan, an ESOP’s
This response is not intended to be comprehensive,
nor does GreatBanc Trust Company or our
affiliates offer tax advice.
operations are governed by the Employee
Retirement Income Security Act (ERISA) and the
Internal Revenue Code. As a result, distributions
from an ESOP are only permitted when one of
The ESOP rollover feature referred to in the
several narrowly defined events occurs. These
question is the ability of shareholders of a C
corporation who sell stock to an ESOP to defer gain events may include termination of employment,
retirement, death or disability. The rules for
on the sale under Section 1042 of the Internal
Revenue Code if certain requirements are satisfied. distributions from leveraged ESOPs may be more
restrictive than these general rules. See your
This option is not currently available to
Summary Plan Description for specific information
shareholders of an S corporation.
about the distribution rules for your plan.
A number of other factors need to be considered
What is Vesting?
before a conversion from S corporation to C
corporation status. These factors include the
Vesting refers to the percentage of the money or
following:
shares in your account that you are entitled to keep
1. Terminating an S election requires consent of when you terminate employment.
shareholders owning more than one-half of
the corporation's stock.
Money that you contribute or defer into your
account, along with any earnings on it, is always
100% vested.
2. Conversion to a C corporation may require
changes to accrual accounting for tax
purposes.
Money that the employer contributes, such as a
contributions to an ESOP, often has a vesting
schedule attached to it. Under a vesting schedule
your vested percentage will generally increase with
each additional year of full-time employment, until
you become 100% vested.
3. There can be restrictions on converting back
to S corporation status for 5 taxable years.
4. If an S corporation converts to C status and
then back to S status, the 10 year waiting
period to avoid built-in gain on the sale of
assets and businesses starts over from the
date of the reconversion to S status.
You can find the vesting schedule for your plan in
your Summary Plan Description (SPD). You may
need to be employed by the Company for a certain
number of years before you become 100% vested in
the money contributed by the employer and the
earnings thereon.
Under the facts described in item 4 above, the
corporation also could acquire liability for tax on
LIFO reserves.
What are the Vesting Rules for ESOPs?
These are just the primary factors that need to be
considered before making a decision to convert a
corporation from S to C status in order to take
advantage of the 1042 deferral for selling
shareholders. As always, you should consult your
tax advisor before taking any action.
Vesting rules are established by each employer.
Sometimes employment is counted from the first
day of employment with a company, while other
times it is counted from the first day of
participation in the ESOP. This information is
disclosed in your Summary Plan Description (SPD).
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increasing and the non-vested percentage of your
account will be handled according to the rules
established in the plan document for forfeitures. In
many plans the non-vested shares are allocated to
the remaining participants and used to increase
their holdings.
When am I Vested in the Portion that I
Contribute?
Participants are always immediately vested in the
money they contribute to a plan. Most ESOPs do
not allow employee contributions (deferrals).
When am I Vested in the Employer
Contributions?
If entitled to a distribution, you may have to wait
until the ESOP stock acquisition loan is paid off in
order to receive it.
The vesting rules for each plan are different. These
are shown in the Summary Plan Description (SPD)
available to you from your company.
How Often Will a Performance Summary Be
Given Out?
What Does it Mean When Shares are
Allocated?
Performance summary availability will depend on
each company. An ESOP maintained by a publicly
When the ESOP is leveraged, shares of employer
traded company may provide quarterly participant
stock held in the trust are often collateral for the
statements, whereas an ESOP of a privately held
loans used to buy those shares. As the loans are
company may only provide annual statements,
paid down, these shares are released from
since private company shares must be valued by an
collateral and become available for allocation to the independent appraiser and usually only once per
ESOP accounts of individual participants.
year.
Some plans have an allocation date (often the plan
year end) on which these shares are actually
allocated to individual participant accounts. After
shares are allocated, they will appear on the next
statement the participant receives. Your statement
will show the total number of shares allocated to
your account, regardless of your vesting
percentage.
When Do the Shares Go into My Account?
For any ESOP, shares go into your account when
they are allocated. The timing for allocation to
participant accounts depends upon the type of
ESOP and the specific provisions of the plan
document. Please see your Summary Plan
Description (SPD).
In a leveraged ESOP, when shares are released
from collateral, they go into a suspense account,
until they are to be allocated in accordance with the
plan provisions.
If you terminate employment, your vesting
percentage is multiplied by the total shares
allocated to your account in order to determine the
amount of your distribution. The allocation of
shares to a participant’s account is unrelated to the
participant’s vesting percentage.
In a non-leveraged ESOP, shares are allocated to
participants according to the plan document.
Can I Roll My Money Over from a Previous
Company?
What Exactly am I Entitled to When I
Terminate Employment? What Happens to
My ESOP Shares if I'm Not Vested?
Normally, you cannot roll money over from a
previous employer's plan into an ESOP. However,
if the ESOP is combined with a 401(k) plan, then
the plan document might allow for rollovers.
Termination of employment is a “distributable
event” under the Employee Retirement Income
Security Act (ERISA). When you terminate
employment, your vesting percentage stops
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Check your Summary Plan Description (SPD) to
find the rules for your plan.
There are three ways to satisfy the diversification
rules:
1. Diversity into cash within 90 days after the
elections period;
What is “Pass-through” Voting?
Shares of company stock held in an ESOP are
actually registered to and owned by the ESOP
trust. The trustee votes all of the shares held in the
trust.
2. Diversify holdings if the ESOP plan offers
three alternative investment options. The
election must be implemented within 90 days
after the last day of the period during which
the election can be made;
In some circumstances, however, participants are
afforded the opportunity to direct the trustee as to
how to vote the shares allocated to their individual
accounts. That is, the vote is passed through to
participants and they are able to direct the trustee
on how to vote the shares allocated to them
individually.
3. Transfer the assets to another plan that offers
the three alternative investment options. The
transfer must be made within 90 days after
the last day of the period during which the
election can be made.
In the first five years of the diversification period,
the participant may diversify up to 25% of the
employer stock that has been allocated on or before
the most recent allocation date. The 25% is applied
to the balance reduced by the prior number of
shares distributed, transferred, or diversified with
previous elections. At the end of the 5 year period,
no more than 25% of the shares allocated to a
qualified individual may be diversified. In the final
(sixth) year of election, the participant may
diversify up to 50% of her or his account balance.
What is “Mirror” Voting?
When the voting of shares is passed-through to
participants, each of them has the opportunity to
direct the trustee on how to vote the shares
allocated to that participant’s account. In a
leveraged ESOP where some shares are not
allocated to participants, the trustee normally
decides how to vote the unallocated shares. Mirror
voting directs the trustee to vote the unallocated
shares in the same way that the participants
directed the voting of the allocated shares.
Will I Receive Statements of my ESOP
Account?
When can I Diversify out of Company
Stock?
Yes. You will receive an individualized statement
showing the number of shares held in the trust for
your benefit, along with the most recent value of
the company shares. It is through these quarterly or
annual individual statements that you can track the
value of your ESOP account.
When participants reach age 55 and have been
participants in the ESOP for more than 10 years,
they are entitled to diversify some of their account
balance out of company stock and into other
investments. There is a very restrictive period
when participants who want to diversify may give
notice to their employer.
What Happens if My Employment is
Terminated?
The qualified election period is a 6 year period that
If your employment is terminated while you are a
participant in an ESOP, you may face specific
choices regarding your plan assets. Many of these
choices depend on the wording of the plan
begins when the participant becomes qualified by
reaching the age and service requirements. The
period runs for 90 days following the end of each
plan year in which the election is available.
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•
document. Please consult your Summary Plan
Description (SPD).
Vesting
The vesting in your account immediately freezes upon
employment termination. You should consult the SPD
for the date when vesting becomes effective. It is often the
last day of the plan year. If this is the case and your
employment is terminated at any time prior to this date,
your vesting stays at the prior year’s level.
Request that the shares of company stock in your
account be re-registered in your name and given to
you. While nothing will be withheld, you will still
owe taxes on the cost value of those shares and
there will be a 10% penalty on that amount when
you file your tax return if you are under age 59½.
Many closely-held companies will not allow a
terminated participant to hold shares and will
require you to sell them to the company at the
price established at the last valuation.
Distribution restrictions
How are ESOP Shares Distributed?
If your company’s ESOP is leveraged, there are often
provisions in the plan document that prohibit or restrict
distributions until the loans are paid off. You may be
required to leave your vested shares with the company
until these restrictions are removed. This can often be for
five years or more after the initial loan. Sometimes,
employers will want to convert your shares to a note but
still not distribute money to you until the loan restrictions
are removed. In this case, they must have adequate
collateral for that note.
The general rules for ESOPs of C Corp companies
allow participants to take any distributions from
their account as shares of company stock. Some
privately-held companies, however, restrict
ownership to employees only. In these cases,
participants are required to take their distributions
in cash.
When possible, because of potential tax benefits,
participants might consider taking distributions in
the form of stock.
Distribution options
What Happens to Distributions under a
Leveraged ESOP?
Once any restrictions have been removed and you wish
to take a distribution, you have the following options:
•
Sell the shares to the company and roll the money
over into a qualified plan of your next employer, if
the new plan accepts rollovers.
•
Roll the shares or money over directly into an
individual retirement account (IRA).
•
Depending upon provisions in the plan document,
distributions of either cash or shares for reasons
other than death, disability or retirement may be
delayed until the acquisition loan is paid off. This
can often take five years or more.
Can I ever Own Other Investments through
Sell the shares to the company and request a check my Company’s ESOP?
written directly to you. In this case, the amount
distributed is fully taxable. The administrator will
withhold 20% of the amount distributed. In
addition, you will owe a 10% penalty on the
amount when you file your tax return if you are
under age 59½.
At age 55, if you have been a participant for more
than 10 years, you may be entitled to diversify
some of your ESOP account out of company stock
and into other investments.
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