What is it?

1. What is it? • A stock bonus plan is defined contribution plan similar to a profit sharing plan, except that accounts are invested in employer stock • An ESOP is a stock bonus plan that the employer can use as a conduit for borrowing money from a bank

2. What is it indicated? • When an employer wants to provide a tax advantages way for employees to acquire company stock at a low cost to itself • When shareholders would benefit from the additional market for company stock created by such plans • When an employer is looking for an advantageous vehicle for borrowing money for business needs

3. Advantages • Employees receive an ownership interest in the employee company • Provides performance incentive for employees • Market is created for employer stock, increasing liquidity for existing shareholders • Employees are not taxed until the shares are distributed

4. Advantages • Taxation of “unrealized appreciation” can generally be deferred until shares are sold by the employee • Employer receives a deduction for the contribution of cash or shares of stock • Overall cost of corporate borrowing can be reduced • Shareholders can obtain tax benefits by selling stock to the plan

5. Disadvantages • Since the plan is qualified, all the qualified plan requirements apply • Issuing shares of stock to employees “dilutes” the stock of existing shareholders and their control of the company • Company stock may be a very speculative investment!

6. Design Features • Participants’ accounts are stated in terms of shares of company stock • Benefits generally distributed in the form of shares of company stock • Dividends can be used to increase participants’ accounts or in cash • Plan allocation formulas may not discriminate in favor of highly compensated employees

7. Design Features • Plan participants must be given certain voting rights depending on whether the stock is publicly traded or not • Participants may demand that distributions be made in company stock • Employer may be required to repurchase company stock that is not traded on an established market (called a “put option”)

8. Design Features • Stock valuations used for all plan purposes must be made by an independent appraiser • ESOPs only – participants who have reached age 55 and have at least ten years of participation must be allowed an annual election to diversify investments in their accounts

9. Design Features • Stock valuations used for all plan purposes must be made by an independent appraiser • ESOPs only – participants who have reached age 55 and have at least ten years of participation must be allowed an annual election to diversify investments in their accounts • ESOPs only – “leveraging” features allow employer to borrow money on a favorable basis

10. Tax Implications • Employer contributions deductible when made • Annual deduction for stock bonus or S corp ESOP is limited to 25% of payroll of covered employees • Annual deduction for C corp ESOP is up to 25% of covered payroll for amounts used to repay loan principal and no limit on amounts used to pay interest • Section 415 limit on annual additions applies to stock bonus plans and S corp ESOPs

11. Tax Implications • C corp ESOPs have higher Section 415 limit in that employer contributions applied by the plan to the payment of interest on certain loans incurred to acquire company stock are not included • Within certain limits, C corporations can deduct dividends paid on stock acquired with an ESOP loan • Taxation of employee is deferred • Special 10-year averaging may apply for lump sum distributions to certain employees born before 1936

12. Tax Implications • Additional benefit of stock bonus/ESOP plans – tax on unrealized appreciation of stock received in a lump sum distribution may be deferred until the employee sells the stock • Shareholders of nonpublicly traded C corporations may not have to recognize gain for income tax purposes when they sell shares to an ESOP under certain conditions