An Employee Stock Ownership Plan, or an ESOP, is a form of retirement plan whereby the employer places shares of stock into an account for employees. This plan places a portion of ownership of the company in the hands of the employees. Certain rules and regulations govern how money is withdrawn from the ESOP.
Early Withdrawal (Cash Out)
An employee may withdraw all or a portion of funds from of their ESOP account at any time. As a result of doing so, the employee will incur a 10% excise tax (penalty) on the amount of money that was withdrawn, in addition to accruing normal income tax on the proceeds.
Rollover to IRA
ESOP participants can choose to transfer, or rollover, the funds in their ESOP account to an Individual Retirement Account (IRA). Federal tax law provides that no taxes will be assessed on funds rolled over to an IRA from an ESOP. The tax will be incurred when the money is withdrawn from the IRA at a later date as ordinary income.
Employee Stock Ownership Plans often pay a cash dividend to the plan participants. These cash dividends are taxable as ordinary income at the time of disbursement. The cash dividend will likely not have taxes withheld, as they are exempt from tax withholding. There are no early withdrawal penalties applied to a cash dividend.
- The ESOP Association: Tax Advantages of ESOP
- National Center for Employee Ownership: ESOP Vesting, Distribution and Diversification Rules
- Internal Revenue Service. "4.72.4 Employee Stock Ownership Plans (ESOPs)." Accessed Oct. 19, 2020.
- United States Code. "From Title 26-Internal Revenue Code, Subtitle A-Income Taxes, Chapter 1-Normal Taxes and Surtaxes, Subchapter O-Gain or Loss on Disposition of Property, Part III-Common Nontaxable Exchanges, §1042. Sales of Stock to Employee Stock Ownership Plans or Certain Cooperatives." Accessed Oct. 19, 2020.
A southeastern Ohio native, Justin Johnson is a finance professional with accounting and financial planning experience in various manufacturing industries. He discovered a love for writing as student at Pensacola Christian College and after learning many lessons in the workplace, he enjoys writing business and finance pieces.