• Employee Stock Ownership Plans (ESOPS) are one way businesses restructure to become employee-owned. In an unleveraged ESOP, the company contributes shares of stock to employees in lieu of retirement funds, such as 401Ks, gradually turning over ownership to workers. In a leveraged ESOP, employees purchase company stock with funds they have borrowed from a commercial lender. Either form of restructuring creates unique ESOP tax consequences that you must take into account when filing your tax return.
  
  

Employer Tax

• Employers can deduct up to 25 percent of their covered payroll -- the salaries of those employees who are ESOP participants -- from their federal taxes. Employers also can deduct any dividend payments on employee-owned stock whether they are paid in cash to the ESOP and distributed to individual shareholders, reinvested in the company by the dividend recipients or designated toward paying off the financing obtained by employees to purchase the stock.
  
  

Employee Tax

• Like most other retirement plans, participants in an ESOP will not pay taxes until stock/funds are withdrawn from the account. Distributions before age 59 1/2 (or age 55 if that is the early retirement age under the plan and the participant is no longer employed by the company) will be taxed an additional 10 percent penalty by the IRS unless the distribution meets the requirements for a qualified rollover into an IRA. Any time the company pays dividends directly to employees, the dividends are taxed as dividend income but are not subject to an early distribution penalty.
  
  

Leveraged ESOPs

• In a leveraged ESOP, the company that is undergoing the restructuring will often guarantee the commercial loan with which employees purchase company stock. The leveraged ESOP employer can choose to pay stock dividends directly to the finance firm as loan payments for the benefit of employees. If so, these funds are not taxable to the company. However, if the company performs poorly during the period of the leveraged loan -- typically 5 to 7 years -- it may be unable to fund the repayment of the loan, thus losing or deferring the associated tax advantages.