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Category: ESOPs

ESOPs: The Business Succession Solution


October 2, 2020

October 2, 2020

An employee stock ownership plan (ESOP) offers you the opportunity to secure your business legacy in a variety of ways. There will always be a tax-exempt buyer for the stock of your company, and you can continue to guide the culture that has benefited your employees and customers over the years. Plus, you will have the financial liquidity to assure that the needs of both your family and your charitable interests have been secured.

Furthermore, you will be free to choose both the future management of and your future role in the business that you have nurtured for many years. After you sell to the ESOP, there is no need to watch from the sidelines unless you choose to do so.

Yes, you can lead the transformation of your business with an (ESOP) that will provide you great after-tax sale proceeds and guarantee continued care for your family, your employees and your customers. Look at these benefits of an ESOP:

  • Create a perpetual tax-exempt market maker for the stock of your company.
  • Eliminate capital gains taxes upon the sale of your stock.
  • Minimize estate taxes and preserve family wealth.
  • Assure the continuity of management and company culture.
  • Eliminate federal income taxes on company profits.
  • Assure continued care for company employees and customers.
  • Grow the family in a family-owned business.

After the ESOP transaction, you can continue to manage the business and continue to build the “ownership culture” that has proven to be the key factor as to why ESOP companies out-perform their non-ESOP counterparts. Employees soon realize they have a “piece of the action” and eventually the “family” in the family business grows to include customers and all other ESOP stakeholders.

If you would like to discuss ESOPs or other business succession solutions for your business, please reach out to us, and we would be happy to help.

Tim Jochim is a partner in the Columbus, Ohio office of Walter | Haverfield and a national authority on business succession and employee stock ownership plans (ESOPs). Tim can be reached at tjochim@walterhav.com or at 614-246-2152.

Business Succession: The Win-Win Solution


September 4, 2020

September 4, 2020

Business owners search for business succession solutions that are financially fair, low cost and tax efficient while also beneficial for employees and customers.  The universe of solutions is usually limited to the following:

            • Transfers to family members which, with family trusts, can be relatively tax efficient for set periods of time, but which tend to restrict the liquidity business owners can obtain from their companies.
            • Sales to financial or strategic buyers which tend to provide a satisfactory sale price, but which tend to be tax inefficient with long-term uncertainty for employees and customers.
            • Management or partner buy-outs which tend to provide a lower sales price and are tax inefficient for the selling owners and very tax inefficient for the companies. 
      • Sales to employee stock ownership plans (ESOPs) which provide a fair sales price, are very tax efficient both for the selling owners and for the companies, and offer continued care for customers and employees.

By selling to ESOPs, business owners are able to establish a perpetual market maker for the stock of the companies, elect to reinvest the sale proceeds in a manner that eliminates any capital gains taxes and, in combination with wealth preservation trusts, protect the sale proceeds from federal estate taxes.

After the ESOP transaction, selling owners can continue to manage the business and continue to build the “ownership culture” that has proven to be the key factor as to why ESOP companies out-perform their non-ESOP counterparts. Employees soon realize they have a “piece of the action” and eventually the “family” in the family business grows to include customers and all other ESOP stakeholders.

If you would like to discuss the above business succession options and determine the best business succession solution for your business, please reach out to us. We would be happy to help.

Tim Jochim is a partner in the Columbus, Ohio office of Walter | Haverfield and a national authority on business succession and employee stock ownership plans (ESOPs). Tim can be reached at tjochim@walterhav.com or at 614-246-2152.

ESOP Grant Act: From Good to Great


August 12, 2020

August 12, 2020

The Temporary Federal ESOP Grant Act, S. 4236, introduced on July 21, 2020, and sponsored by Sen. Ron Johnson (R-WI) and Sen. Tammy Baldwin (D-WI), could be a major event for the ESOP community. The major provisions, as currently written, are set forth below.

ESOP Grant Act Current Version

  1. A grant from the Treasury Department directly to a company that either (a) forms a new ESOP or (b) increases the percentage of company ownership of an existing ESOP. (Section 2(b)(1) of the Act).
  2. A documented valuation of the sponsor company by an independent valuation expert using approaches determined by Treasury or by the trustee of the ESOP. (Section 2(b)(2) of the Act).
  3. The grant can be up to $20,000 per ESOP participant plus up to $50,000 for documented costs related to the grant process and the ESOP. (Section 2(c) of the Act).
  4. Certification that the grant will be applied to the purchase of sponsor company stock with cost reductions to the company resulting from the grant applied to the purchase of equipment, computers, land, buildings, facilities, health and safety equipment, and similar investments. (Section 2(b)(3) of the Act).
  5. Funding for the grants may be taken from unused CARES Act appropriations. No grants will be awarded by Treasury after September 30, 2022. (Sections 2(d) and (e) of the Act).

ESOP Grant Act Suggested Changes

However, certain provisions of the Act are unclear or maybe redundant to existing ESOP law and regulation, and other provisions could be expanded. I suggest the following changes and clarifications:

  1. Section 2(b)(1) could be expanded to include a company 100% owned by its ESOP to the extent the grant is used to increase the number of ESOP participants (up to $20,000 for each new ESOP participant).
  2. The valuation procedure under Section 2(b)(2) appears to be confusing or redundant and could simply reference the existing ESOP valuation provisions under ERISA Section 3(18) and Code Section 401(a)(28)(C).
  3. Section 2(b)(3) should clarify that grants are to be used for the purchase of newly-issued sponsor company stock by the ESOP and not for the purchase of sponsor company stock from non-ESOP shareholders.
  4. Because the grants are related to temporary coronavirus relief and not to earned employee compensation, the grant funds, or the sponsor company stock purchased by the funds, should be allocated equally among all ESOP participants. Generally, lower-income participants need relief more than higher-income participants. Thus, the Act should state that this will be considered a “safe harbor” allocation under Code Section 401(a)(4).
  5. Because some ESOP companies have existing ESOP loans, and many mature ESOP companies have significant repurchase obligations, including repurchase loans, the $20,000 per participant could exceed the 25% contribution limit under Code Section 404(a) and/or the $57,000 annual addition limit under Code Section 415(c). Thus, the Act should exempt the grants from both the contribution limit and the annual addition limit.

Tim Jochim is a partner in the Columbus, Ohio office of Walter | Haverfield and a national authority on business succession and employee stock ownership plans (ESOPs). Tim can be reached at tjochim@walterhav.com or at 614-246-2152.

ESOPs: A New Normal

and
June 3, 2020

Russell ShawDuring the best of times and during the worst of times, companies with employee stock ownership plans (ESOPs) have proven to perform better than non-ESOP peer companies as measured by profitability, jobs gains and fewer job losses. Long-term studies conducted at the University of Pennsylvania and at Rutgers University have indicated higher profitability, higher job growth and increased longevity with the ESOP business model. During the Great Recession, survey results from the 2015 General Social Survey at the University of Chicago indicated lower lay off rates for ESOP companies compared with non-ESOP companies during 2010 and 2014. Another survey conducted at Georgetown University indicated that ESOP Subchapter S corporations actually added jobs during 2008 while comparable companies in the same industries were cutting jobs.

The National Center for Employee Ownership (“NCEO”) issues periodic reports on benefits in ESOP companies compared to benefits in non-ESOP companies. A recent report indicated that the average contribution by ESOP companies to their ESOPs was approximately 9.7% of eligible employee compensation compared to approximately 4.0% for non-ESOP companies (primarily to 401(k) plans). Thus, compared to employees of non-ESOP companies, employees of ESOP companies are more likely to retain their jobs until retirement and, when they do retire, they are likely to have higher retirement benefits. Further, taxpayers also get relief because unemployment compensation costs will tend to be lower for ESOP company employees.

Despite the apparent superior performance of ESOP companies compared with non-ESOP peer companies, the NCEO has reported a decrease in the number of ESOP companies from nearly 9,000 for 2002 to approximately 7,000 for 2019. The NCEO has also estimated that there are approximately 500,000 closely-held companies in the United States with at least 20 employees. The 20-employee threshold is important because the cost and complexity of forming and maintaining an ESOP excludes many, if not most companies, below the threshold and, in addition, S corporation ESOPs may have difficulty meeting certain regulatory compliance tests if they have fewer than 20 employees.

The coronavirus pandemic and the ongoing threat of COVID-19 warrants a re-examination of both business strategy and public policy with respect to ESOPs and ESOP formations. It is near certainty that U.S. fiscal policy going forward will migrate towards a neo-Keynesian stimulation of aggregate demand (i.e., consumer spending) and increased public funding of health care. The CARES Act and the monetary expansion by the Federal Reserve are only the current manifestations of the former while the Families First Act and the expansion of Medicaid are only the initial steps as to the latter (includes some uncoupling of health care from employment).

Why are ESOPs the solution?

First, ESOPs facilitate business survival and longevity. Over time, this could mean millions of jobs saved and billions of taxpayer dollars saved.

Second, ESOPs offer financial incentives that cannot be matched by any other form of business. These include, but are not limited to, tax deferred or tax exempt stock sales to ESOPs sponsored by C corporations and exemption from federal income taxes (UBIT) to the extent of ESOP ownership of S corporations.

Third, because of the tax and financial benefits, ESOPs facilitate family wealth and legacy planning, including the funding of any charitable interests.

Fourth, ESOPs facilitate the continuation and growth of company culture built by the founders and selling shareholders.

Fifth, ESOPs facilitate the broad-based capital ownership of companies providing millions of employees with both a piece of the action and equity incentives.

Sixth, ESOPs facilitate the continued participation, if not the continued control, of ESOP companies by the shareholders selling to the ESOPs.

Seventh, given that nearly all ESOP companies are closely-held (not publicly traded), the stock value of ESOP companies tends to be somewhat insulated from the volatility of the established securities markets because stock value tends to be determined based on company performance.

Eighth, ESOPs facilitate acquisitions on a tax-efficient basis because, under certain circumstances, ESOP tax advantages can be passed on to the shareholders of target companies and because, as to S corporation ESOPs, there are no adverse tax consequences.

What’s Next?

Please contact our ESOP team and allow us to provide you a safe and secure pathway to attainment of your business and personal goals.

Tim Jochim is a partner in the Columbus, Ohio office of Walter | Haverfield and a national authority on business succession and employee stock ownership plans (ESOPs). Tim can be reached at tjochim@walterhav.com or at 614-246-2152.

Russell Shaw is a partner in the Cleveland, Ohio office of Walter | Haverfield and focuses his practice on employee benefits, which include retirement plans, executive deferred compensation plans, welfare benefit plans, VEBAs, and 403(b) tax-deferred annuity plans. Russ can be reached at rshaw@walterhav.com or at 216-928-2888.

The SECURE Act: What You Need to Know


February 17, 2020

The SECURE Act became law on December 20, 2019.  Retirement plan sponsors, fiduciaries, and third party administrators must understand and implement several changes in pension law that affect employee stock ownership plans (ESOPs), 401(k) plans, and simplified employee pension plans (SEPs). Walter | Haverfield is providing this summary of key provisions to our valued clients and business partners. We are ready to help you understand and implement these changes.

Common Plan Changes.

The SECURE Act makes several changes that apply to all retirement plans as set forth, below.

  1. Increases the credit for small start-up costs incurred by employer pension plans.
  2. Creates a new credit to defray the start-up costs of plans with automatic enrollment.
  3. Prohibits plans from making loans through credit cards and other similar arrangements.
  4. Permits penalty-free withdrawals from retirement plans for birth or adoption.
  5. Increases the age at which required minimum distributions (RMDs) must start from 70½ to 72 (for individuals who have not reached age 70½ as of December 31, 2019).
  6. Changes the permitted distribution periods for beneficiaries.
  7. Requires annual “lifetime income disclosures,” which must illustrate the monthly payments if a participant used his or her account balance to provide lifetime income as an annuity.

 

How Does the SECURE Act Affect 401(k) Plans?

The Act permits long-term part-time workers to participate in 401(k) plans. Previously, employers could exclude part-time workers with fewer than 1,000 hours of service per year. Now, plans must include a dual eligibility requirement: 1,000 hours of service in any one year (or other 12-month period specified in the plan) or 500 hours of service for each of three consecutive years. Service in years before 2021 need not be taken into account.

The Act changes the automatic enrollment safe harbor cap and the safe harbor plan notice requirements. The Act increases the automatic enrollment safe harbor cap on elective deferrals from 10% of employee compensation to 15%. Automatic enrollment permits employers to automatically deduct elective deferrals from an employee’s wages. The Act also eliminates the safe harbor notice requirement for plans that satisfy the safe harbor by providing non-elective contributions. The requirement that employees be entitled to make or change an election at least once per year continues to apply.

The Act also requires that inherited pension benefits generally must be distributed within 10 years of the participant’s death. This does not apply to surviving spouse beneficiaries, chronically ill beneficiaries, beneficiaries who are not more than ten years younger than the participant, or beneficiaries who are children of the participant and have not reached the age of majority.  Such beneficiaries generally may receive distributions over the life or life expectancy of the participant, except that the 10-year distribution rule will apply to minor children when they reach the age of majority for any undistributed amounts.

Penalty-free withdrawals on birth or adoption, the prohibition on plan loans through credit cards, the new age for beginning required minimum distributions, and the lifetime income disclosure requirements all apply to 401(k) plans.

 

How Does the SECURE Act Affect ESOPs?

The Act’s new hours of service requirements do not apply to ESOPs.  Plan sponsors may still exclude part-time workers who do not work 1,000 hours of service in a year from participation in their ESOPs.

The Act also requires that inherited pension benefits generally must be distributed within 10 years of the participant’s death. This does not apply to surviving spouse beneficiaries, chronically ill beneficiaries, beneficiaries who are not more than ten years younger than the participant, or beneficiaries who are children of the participant and have not reached the age of majority.  Such beneficiaries generally may receive distributions over the life or life expectancy of the participant, except that the 10-year distribution rule will apply to minor children when they reach the age of majority for any undistributed amounts.

Penalty-free withdrawals on birth or adoption, the prohibition on plan loans through credit cards, the new age for beginning required minimum distributions, and the lifetime income disclosure requirements all apply to ESOPs.

 

How Does the SECURE Act Affect SEPs?

SEPs, otherwise known as SEP IRAs, are essentially traditional IRAs that permit employer contributions. Therefore, the SECURE Act’s IRA provisions apply. The Act repeals the maximum age for IRA contributions. Previously, individuals could not contribute to their IRA once they reached age 70½.

The Act’s new hours of service requirements do not apply to SEPs, so plan sponsors may still exclude part-time workers who do not work 1,000 hours of service in a year from participation in their SEPs.

The Act also requires that inherited pension benefits generally must be distributed within 10 years of the participant’s death. This does not apply to surviving spouse beneficiaries, chronically ill beneficiaries, beneficiaries who are not more than ten years younger than the employee, or beneficiaries who are children of the employee and have not reached the age of majority.  Such beneficiaries generally may receive distributions over the life or life expectancy of the employee, except that the 10-year distribution rule will apply to minor children when they reach the age of majority for any undistributed amounts.

Penalty-free withdrawals on birth or adoption, the prohibition on plan loans through credit cards, the new age for beginning required minimum distributions, and the lifetime income disclosure requirements all apply to SEPs.

 

Effective Dates.

The effective dates for SECURE Act provisions vary by tax, calendar and plan years, with some modifications taking effect in 2020, and others in 2021. The effective dates for major provisions are listed below.

  1. Effective December 20, 2019, the date the Act became law.
  • Prohibition on making loans through credit cards and similar arrangements
  1. Effective for plan years beginning after December 31, 2019.
  • 401(k) automatic enrollment safe harbor cap increase
  • Elimination of safe harbor notice requirement
  • Distribution on birth of child or adoption
  1. Effective for tax years beginning after December 31, 2019.
  • Increase in credit limit for small employer plan startup costs
  • Small employer auto-enrollment credit
  • Repeal of maximum age for IRA contributions
  • Penalty-free withdrawals for birth or adoption
  • Increase in age for required minimum distributions
  1. Effective for plan years beginning after December 31, 2020.
  • New hours of service requirements for 401(k) plans
  1. Effective for benefit statements furnished more than one year after the DOL issues guidance.
  • Lifetime income disclosures

Plan Amendments.

Retirement plans must comply in operation with SECURE Act provisions by the effective dates specified above, however, plans will not be considered out of compliance, provided that the plan documents are amended, consistent with operation of the plan, to incorporate these provisions by the last day of the first plan year beginning on or after January 1, 2022.

Other Provisions.

The SECURE Act has a number of other provisions, including annuity forms of payment and distribution, a safe harbor for selection of an annuity provider, changes to multiple employer plans, relief for certain frozen or closed defined benefit plans, funding relief for certain “community newspaper plans,” the ability to adopt a plan effective for the preceding taxable year, and increased penalties for certain failures with respect to Form 5500 filings.

Additional Information.

As to ESOPs:

Tim Jochim, Partner

175 S. Third Street, Suite 290

Columbus, OH 43215

614-246-2152

tjochim@walterhav.com

As to all Plans:

Russell C. Shaw, Partner

1301 E. Ninth Street, Suite 3500

Cleveland, OH 44114

216-928-2888

rshaw@walterhav.com

Petra J. Bradbury, Associate

1301 E. Ninth Street, Suite 3500

Cleveland, OH 44114

216-619-7841

pbradbury@walterhav.com