Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

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Can employees help pay off an ESOP loan?

On October 13, 1994, the IRS issued a technical advice memorandum (TAM 95030002) saying that employees could make voluntary pretax contributions to their ESOP or ESOP/401(k) plans to help pay off an ESOP loan. An employee, for instance, might defer 2% of pay to help pay off the loan, receiving an equivalent value in company shares above what would otherwise be contributed. While the IRS thought this was fine, in a January 16, 1996, letter to the IRS, the Department of Labor (DOL) disagreed. The DOL argued that "the use of participant contributions to repay the exempt [ESOP] loan... serves directly to relieve the employer of its obligation to contribute to the plan." The DOL also contended the participant would forego other investment opportunities that might be better.

ESOP consultants have argued that the DOL position precludes employees from making a purely voluntary choice. As long as there is no coercion, and the employee is provided with appropriate information concerning the risks of the decision involved, they argued, there should not be a problem. In its letter, the DOL asked the IRS to change its position, but it did not, so the TAM would stand and, presumably, companies could continue to allow such contributions.

Regardless, we are not aware of any company that has done this. Some companies, however, allow employees to purchase shares in an ESOP or combined 401(k) and ESOP with either their elective deferrals and/or existing cash balances. This would be done outside what the loan buys. These purchases are subject to securities laws and disclosure requirements as well as heightened fiduciary concerns about the prudence of allowing employees to purchase shares. Most advisors recommend that only a portion, such as one-third or less, of existing account balances, be available to purchaser shares to help avoid fiduciary issues.

Link to this FAQ Topic: Financing an ESOP