Stock Bonus Plan

The stock bonus plan is the older of the two types of qualified plans that invest primarily in employer securities. Under the regulations, a stock bonus plan is a qualified defined-contribution plan similar to a profit-sharing plan, except that the employer's contributions are not necessarily dependent on profits; benefits are distributable in the stock of the employer company.

Typically, the plan contribution formula is based on employee compensation. Employer contributions to the plan may be made in cash or directly in the form of employer securities, newly issued or otherwise. Shares of stock are allocated to participants' accounts under a formula that must meet the same nondiscrimination requirements as the allocation formula in a profit-sharing plan. Some stock bonus plans also provide for after-tax employee contributions or salary reductions. (A salary reduction stock plan is sometimes referred to as a KSOP.)

The value of each participant's account in a stock bonus plan is stated in terms of a certain number of shares of employer stock. The value of the account varies with the value of the underlying employer stock. Dividends on the shares can be used to increase participants' accounts, or cash dividends can be paid through the plan directly to participants as currently taxable income, in which case the employer gets a tax deduction.

Plan Distributions

Distributions from both stock bonus plans and ESOPs are generally subject to the same restrictions applicable to distributions from any qualified plan. Thus, distributions prior to age 59½, death, disability, or retirement are subject to a 10 percent penalty, with some exceptions. However, for a stock bonus plan or ESOP, there is no requirement of providing a joint and survivor annuity or other spousal death benefit.

Because an employee retains the investment risk in the employer company until the stock is distributed, a deferred distribution to a terminated employee would not be appropriate, so payouts from stock bonus plans or ESOPs have a special earlier beginning date than that for other qualified plans. Distributions from a stock bonus plan or ESOP must occur no later than one year after the end of the fifth plan year after the employee's separation from service or no later than one year after retirement, disability, or death.

In general, the plan must distribute benefits in the form of employer stock. However, the participant can be given the option of receiving cash of equal value, subject to a right to receive employer stock. If the participant receives stock that is not traded on an established market, the participant has a right to require that the employer repurchase the securities under a fair valuation formula. This is referred to as the "put" requirement. If an employee exercises the put option on distribution—that is, sells the securities back to the plan—the participant must be paid over no more than five years, and during that time the plan must provide adequate security for the payment.

Voting Rights

If the employer company is closely held, plan participants must be given the right to vote with respect to stock held for them in the plan on corporate issues requiring more than a majority of the outstanding common shares. If the employer stock is publicly traded, participants must be permitted to vote on all issues.

Taxation of Employees

In addition to the usual tax advantages for qualified plans, an additional employee tax benefit provided by the Code for a plan holding employer stock is the deferral of taxation of unrealized appreciation. When the plan makes a lump-sum distribution including employer stock, the unrealized appreciation of the stock—that is, the difference between the value of the stock when contributed to or purchased by the trust and its value when distributed to the employee—is not taxable to the employee at the time of the distribution to the extent that it (1) represents nondeductible employee contributions or (2) represents employer contributions, and the participant's entire account is distributed within one taxable year as a result of death, the attainment of age 59½, or the employee's separation from the service of the employer.

This means that the taxable amount of a lump-sum distribution from a stock bonus plan does not include unrealized appreciation of employer securities if the recipient is entitled to the special tax treatment for lump-sum distributions in general. The unrealized appreciation is taxable only when the employee or other recipient sells the securities at a later date. The unrealized appreciation amount is taxable as a capital gain when the stock is sold.

Deductibility of Contributions

As indicated above, the employer can deduct a contribution to a stock bonus plan in the form of employer securities as well as cash. Deductions for contributions can be taken even if there are no current or accumulated profits. The deduction limit is the same as that for a profit-sharing plan—15 percent of covered payroll.