plan that gives employees a share in the profits of the company. Eachemployee receives a percentage of those profits based on thecompanys earnings.Also known as "deferred profit-sharing plan" or "DPSP".This is a great way to give employees a sense of ownership in the company.The company decides what portion of the profit will be shared. And thereare typically restrictions as to when and how you can withdraw these fundswithout penaltiesA stock option granted to specified employees of a company. ESOs carry theright, but not the obligation, to buy a certain amount of shares in thecompany at a predetermined price. An employee stock option is slightlydifferent from a regular exchange-traded option because it is not generallytraded on an exchange, and there is no put component. Furthermore,employees typically must wait a specified vesting period before beingallowed to exercise the option.The idea behind stock options is to align incentives between the employeesand shareholders of a company. Shareholders want to see the stockappreciate, so rewarding employees when the stock goes up ensures, intheory, that everyone is striving for the same goals. Critics point out,however, that there is a big difference between an option and the ownershipof the underlying stock. If the stock goes down, the holder of an optionwould lose the opportunity for a bonus, but wouldnt feel the same pain asthe owner of the stock. This is especially true with employee stock optionsbecause they are often granted without any cash outlay from the employee.Another problem with employee stock options is the debate over how tovalue them and the extent to which they are an expense on the incomestatement. This is an ongoing issue in the U.S. and most countries in thedeveloped world.A qualified, defined contribution, employee benefit (ERISA) plan designedto invest primarily in the stock of the sponsoring employer. ESOPsare "qualified" in the sense that the ESOPs sponsoring company, the sellingshareholder and participants receive various tax benefits. ESOPs are oftenused as a corporate finance strategy and are also used to align the interests ofa companys employees with those of the companys shareholders.Employee stock ownership plans can be used to keep planparticipants focused on company performance and share price appreciation.By giving plan participants an interest in seeing that the companys stock
performs well, these plans are believed to encourage participants to dowhats best for shareholders, since the participants themselves areshareholdersStock Options/Profit SharingOften used as a tool to retain employees, stock options have a growingappeal in todays job market. Depending on the business and industry, stockoptions can be a very valuable and enticing benefit to offer employees andpotential employees. Deciding to offer stock options is a no-brainer;deciding on the type of option plan is another story.There are three classes of stock options: incentive stock options (ISO),employee stock purchase plan options, and nonqualified options.The most popular plans are ISOs and nonqualified plans. With both of theseplans, the employee is offered a specific number of shares that they canpurchase (exercise) on a specified date. The shares can be purchased at thevalue of the stock at the time the option was granted. So, if the stocks valuehas increased when the employees exercise their option, then they get a gooddeal; if not, then the stock options are worth nothing.These two plans differ in the way the money is taxed. With ISOs, theemployees pay no taxes until they later sell the shares they have bought(exercised). At that time, any money they made off of the transaction issubject to capital gains tax instead of income tax. They must, however, makesure they dont sell the shares for at least two years after the time the optionwas granted or within one year after they exercised their option (bought thestock). Another thing to consider is that there is no corporate deductionwhen the employee exercises the option.With nonqualified plans, the tax situation is different. Employees will haveto pay income tax on any gains they made when they exercised their options(assuming the employee is making a profit based on the current value of thestock). For example, if the stock was valued at $2 per share when the optionswere granted and is valued at $5 when the options are exercised, thenordinary income tax must be paid on the gain of $3 per share. There can alsobe a corporate deduction on the same amount. Later, if the employee keepsthe stock and it increases more in value, then they will only owe capitalgains tax on the additional increase in value when they sell.
Employee stock purchase plans are another option for employers who wantto lure new recruits. Unlike the ISOs and nonqualified plans, employee stockpurchase plans are usually offered to all eligible employees. Employees canpurchase the stock at usually about 85% of its market value. Mostcompanies allow employees to purchase stock amounts up to 10% of totalpay, and offer payroll deductions for payment.Another lesser-known option particularly appealing for small and privatecompanies is the phantom-stock plan. Phantom-stock plans operate in asimilar manner as the other stock options, but the risk of sharing equity inthe company isnt there. You can issue shares to your employees at a setprice based on your companys current value, then on a specified future datereevaluate the companys value. If the stock has risen and the employeewants to sell, then you cut a check to the employee for the increased amount.Your employee will pay tax on the additional "wages," and your companycan take a tax deduction.Profit Sharing PlansAbout 40% of companies offer profit sharing plans. Profit sharing programsrequire setting up a formula for distribution of company profits. The formulais usually based on 5% to 6% of the employees salary. They usually includea vesting period of up to seven years. The good thing about profit sharingplans is that they allow you to decide if and how much your companycontributes to the plan. During less profitable years, you may opt to notcontribute. It also lets you control how the money is invested and is not asexpensive to administer as other plans.Employee Stock Ownership Plans (ESOPs)ESOPs are the most common form of employee ownership in the UnitedStates. They allow your employees to own a part of the company withoutrequiring them to purchase stock. Your company can be either public orprivate, and stock is usually transferred to the employees through annualcontributions. ESOPs, like the other employee stock ownership methods, canimprove your bottom line through employees heightened awareness andvested interest in helping the company be successful. If you are interested intransferring some or all ownership to your employees, then this might be agood option for your company. The contributions are tax deductible, you canborrow against the ESOP, and stock owners can sell their shares back to thecompany when they leave and escape paying taxes if the money from thesale is transferred into another security. ESOP accounts are tax deferred untilretirement.