Employee stock ownership plans have tax advantages for both the companies that sponsor them and for their employees. If a company's ESOP follows the rules for IRS qualification, its contributions to the ESOP trust are tax-deductible.
Companies can deduct the entire principal and interest on any loan contributions made to the ESOP. Corporate contributions to the fund are also tax-deductible at 25% of pay for S corporations and 25% of pay for C corporations. Within limitations, they can also deduct dividends that they pay out to employees.
Tax benefits for employees
Employees don't pay any income tax on their stock allocations until they begin receiving their distributions. If distributions are taken in the form of stock shares, then income tax on a portion of the value of the stock received can be further deferred until the shares are sold.
Dividends received from distributed stock shares, as well as cash distributions from the plan, are taxed at ordinary income rates.
If employees receive their benefits before age 59½, they will also be charged a 10% penalty.
All ESOP benefits remain tax-deferred if they are rolled over into individual retirement accounts (IRA) or qualified company plans. However, minimum required distributions must begin by April 1 of the year after which employees reach age 70½.
Dive Deeper: Employee stock ownership plans: The full breakdown
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