• An ESOP is an employee stock ownership plan that works like a qualified retirement deferred compensation plan that permits an employee to invest in securities held by the employer, usually in a tax-exempt manner. ESOPs are part of the Employee Retirement Income Security Act of 1974 (ERISA) and are regulated by the Internal Revenue Service.
  
  

Basic Requirements

• Two main sets of rules to which all ESOPs adhere before disbursements are made to participating employees are the nondiscrimination rules and coverage rules. Discrimination rules provide that an ESOP generally is not structured where disbursements favor highly compensated employees--who are 5 percent company owners--with salaries in excess of $80,000 and in the top 20 percentile of paid employees. Coverage rules guard against an employer operating an ESOP that does not, at minimum, generally cover 70 percent of its non-highly compensated employees.
  
  

Types of Disbursements

• According to the Employee Plans Technical Guidelines in Chapter 72 of the Internal Revenue Manual, ESOPs provide two ways in which the benefits of the plan can be disbursed to participating employees. Based upon contents of the employer's corporate charter and bylaws, an employee may demand that disbursements be made in employer securities. Or, the employee can demand that the employer essentially buy back the employer securities in cash.
  
  

Classes of Disbursements

• The IRS requires that whenever an ESOP is based upon more that one class of employer securities, when the proceeds of the ESOP are distributed to the employee, the proceeds will be disbursed in the same ratio as the different classes that make up the ESOP.
  
  An example is when an ESOP is made up of 30 percent voting stock, the disbursement will also consist of 30% voting stock.
  
  

Early Disbursements

• Normally, depending on the amount of an employee's ESOP account balance--up to the $800,000 limit--the employee will receive equal disbursements throughout a five-year disbursement period. Balances more than $800,000 receive an additional year for every $160,000 over the limit, according to the IRS.
  
  However, a qualifying employee can use the provisions in Title 26 USC § 409(o) to demand that the employer accelerate disbursements, in some cases reducing the five-year disbursement period to an one-year disbursement period.