Stock-purchase plans

There are different ways that you can use shares of your stock as employee compensation. You may decide to fund employee retirement accounts with shares using an employee stock ownership plan (ESOP). ESOPs are a form of deferred compensation since you are contributing to retirement accounts.

Instead of an ESOP, you may decide to grant your employees an option to buy shares of your stock at a discount to the market price. To administer this kind of program, you use an employee stock-purchase plan (ESPP). ESPPs are also called Section 423 stock-purchase plans after the section of tax code that governs their use.

Unlike ESOPs, ESPPs are not deferred compensation. As a result, they are not subject to compliance with ERISA, the federal law that regulates employers' treatment of retirement plans.

Instead, ESPPs are a benefit that allows employees to buy shares of the employee's company stock at a discount to the market price of the stock. This discount is often in the vicinity of 15% of the market price.

For example, if the market price of your shares is $30 and you offer a 15% discount, you would sell them to employees at $25.50 a share using an ESPP. To ensure you have the shares on hand to sell, you buy them ahead of time and record a loss for the amount of discount you paid. In this case, the $4.50 price difference is considered an expense. Generally, you cannot take a tax deduction for expenses relating to administration of an ESPP.

Unlike stock options, which are often limited to key employees, ESPPs are for rank-and-file employees. To take advantage of the tax benefits, you generally must make an ESPP available to all eligible employees.

Like all forms of stock-related compensation, ESPPs are aimed at aligning employee's financial interests with those of your company. As employees also become shareholders, they are likely to work harder to protect their investment. An employer provides shares for an ESPP in a custodial account. The ESPP buys back the shares of departing employees who sell their shares they bought from the ESPP.

For additional information on ESOPs and ESPPs, including tax treatment, see the Web site of the National Center for Employee Ownership (NCEO). NCEO is a non-profit organization that specializes in legal and technical information of setting up and administering stock-related compensation plans.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.