employee will not be entitled. Forfeitures are usually allocated among the ESOP accounts of the remaining employees on the same basis as employer payments to the ESOP are allocated. The vesting schedule applies only where an employee does not end his employment because of retirement or, in some cases death. If an employee retires, or, in some cases if he dies, he will immediately have a 100-percent vested interest in all ESOP assets held for him. When Do I Receive What I Own From the ESOP? Even though employer stock and cash are usually put into the ESOP for an employee each year, and put into a special account under his name, he will normally not be able to actually get any employer stock and cash from the ESOP until after his employment with the employer terminates and he ceases to be a participant in the ESOP. After an employee's participation in the ESOP ends, he (or his beneficiary) will be eligible to receive a payment of his vested interest. There are many permissible times and methods for making the payment to him from the ESOP. For example, an ESOP may provide that payment will be made as soon as possible after an employee's termination of employment. On the other hand, the ESOP may require that any payment be deferred until some later time, such as the normal retirement date set forth in the ESOP or the employee's death. However, payment of a former employee's vested benefit under the ESOP must start soon after his death or attainment of age 65. Payment may be made to a former employee (or his beneficiary) in a lump sum, or it may be made in installments. Payment of an employee's vested interest from an ESOP must normally be made in as many whole shares of employer stock as possible, with the value of any fractional share being paid in cash. Occasionally, depending upon how the ESOP is set up, the ESOP may pay a portion of an employee's vested interest in cash. However, this is not the usual case. What Can I Do With My Shares of Employer Stock From the ESOP? Once a former employee (or his beneficiary) gets his shares of employer stock from the ESOP, they are his property and he can do what he wants with them. He can vote the shares of employer stock at shareholders' meetings, receive any dividends paid on the stock by the employer, and he may keep the stock as long as he wishes. However, if he wishes to sell or otherwise transfer ownership of the stock to a third party, he may be required by the terms of the ESOP to first offer to sell the stock to the employer and the ESOP. This requirement is called a "right of first refusal" for the employer and the ESOP; they can exercise this right and purchase the employer stock at its fair market value. Generally, the price offered by the prospective buyer would establish the fair market value for the stock. However, if an independent party hired by the employer decides that the fair market value is higher than the offering price, then that would be the fair market value of the stock when it is sold to the employer or the ESOP. The purpose of this right of first refusal is to protect the employees of a closely held employer by preventing the stock from being acquired by outside parties who have no interest in the employer or the ESOP and to protect the employer from violating any Federal law as a result of having its stock sold when it does not no satisfy certain Government rules. In addition, at the time the former employee (or his beneficiary) receives his employer stock from the ESOP, he may be given a "put option," the right to demand that the employer buy his shares of employer stock at their fair market value. In such a case, the ESOP may provide that the ESOP may buy the employer stock, although the ESOP may not be required to buy the stock under the put option. The purpose for including a put option in the ESOP is to assure that each former employee (or his beneficiary) will have someone available to buy his shares of employer stock if he wishes to sell. How Does the ESOP Help My Employer? The employer benefits primarily from the favorable tax treatment it receives for all payments made to the ESOP. This is very important when the employer uses the ESOP as a means of borrowing money. In order to understand how the use of the ESOP to raise money benefits the employer, a comparison must be made with the usual method of borrowing money. If an employer which does not have an ESOP wishes to borrow money to build a new building, expand production, or for any other reason, the employer would go to a bank to borrow money. When the employer repays the loan, it will also pay interest on the loan, just like an individual person would do with a charge account. Although the interest payments would be tax deductible, the principal payments on the loan would not. This means that the employer would first figure its taxable income, then pay its income taxes, and then make its payment on the loan. The use of an ESOP for this purpose greatly helps the employer because of the effect it has on the employer's taxes. In this situation, the ESOP borrows the money from a bank, and signs a promissory note for the money: BANK promissory ESOP |