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ESOPs

Book Description

Changing demographics, impending changes in taxation, and challenging economic conditions have made ESOPs a creative strategy to ensure organization survival and success. This publication defines issues that must be fully considered before installing an ESOP, and highlights the common attributes of successful installations. Use this book to chart a course through succession issues and transition ownership issues with a minimum impact to financial results.  The book offers you practical strategies to deal with current economic realities and taxation challenges, including the following: 

  • Increasing tax rates in the near future will make ESOPs a tax efficient option for business owners. 
  • In recessionary times ESOPs control the succession process versus letting probate and inheritance taxes jeopardize the survival of their organization. 
  • Financing for almost any business transaction is difficult; ESOPs are very seller finance friendly. 
ESOPs represent an effective exit vehicle for Baby Boomer owners.

Table of Contents

  1. Cover Page
  2. Title Page
  3. Copyright Page
  4. Contents
  5. Introduction
  6. Chapter 1: Employee Stock Ownership Plan History and Background
    1. Overview of Employee Ownership and Employee Stock Ownership Plans
      1. Underlying Philosophy of ESOPs
    2. Legislative History
      1. Employee Retirement Income Security Act of 1974
      2. Revenue Act of 1978
      3. The Chrysler Loan Guarantee Act of 1979
      4. The Economic Recovery Tax Act of 1981
      5. Deficit Reduction Act of 1984
      6. Tax Reform Act of 1986
      7. Small Business Job Protection Act of 1996
      8. Taxpayer Relief Act of 1997
      9. The Economic Growth and Tax Relief Reconciliation Act of 2001
      10. Jobs and Growth Tax Relief Reconciliation Act of 2003
      11. Impact on ESOPs
      12. ESOPs Today
    3. Summary
  7. Chapter 2: Significant Events and Organizations
    1. Regulations and Government Agencies
      1. Employee Retirement Income Security Act of 1974
      2. IRS
      3. Securities and Exchange Commission
      4. DOL
      5. General ERISA Fiduciary Considerations
      6. Proposed DOL Regulations Specific to ESOP Valuations
      7. Major Exceptions to ERISA for the Benefit of ESOPs
      8. ESOP and ERISA Litigation
      9. Summary
    2. Industry Organizations and Standards
      1. The AICPA
      2. The ESOP Association
      3. National Center for Employee Ownership (NCEO)
      4. Ohio Employee Ownership Center
    3. Appendix 2A—IRS Form 5309, Application for Determination of Employee Stock Ownership Plan
  8. Chapter 3: Employee Stock Ownership Plan Transaction Mechanics
    1. Traditional Uses of an ESOP
      1. Provide Liquidity and Diversification for Shareholders
      2. Provide a Means of Capital Formation
      3. Finance Corporate Acquisitions
      4. An Incentive to Increase Employee Productivity and Retain Personnel
      5. Provide a Succession Plan
      6. Provide Liquidity in Divorce Situations
      7. Provide Negotiating Leverage for Any Proposed Transaction
      8. Summary
    2. Alternatives to an ESOP
      1. Sell or Transition the Business to Family Members
      2. Sell to Management or Key Employees
      3. Sell or Merge With a Third Party—Financial Buyer
      4. Sell or Merge With a Third Party—Strategic or Investment Buyer
      5. Sell Stock Through an Initial Public Offering
      6. Liquidate the Business
      7. Summary
    3. Basic Features of ESOPs
      1. Operating Considerations of an ESOP
      2. Contributions to an ESOP Are Tax Deductible Within Statutory Limits
      3. Contributions to an ESOP Based on Dividends (C Corporation)
      4. Contributions to an ESOP Based on Distributions (S Corporation)
      5. IRC Section 1042 Tax-Free Rollover (C Corporation)
      6. Nontaxable Income Related to ESOP Stock (S Corporation)
      7. Assets in ESOP Remain Untaxed Until Retirement
    4. Appendix 3A—Sample Documents Relating to the Internal Revenue Code Section 1042 Election
      1. Sample Statement of Election
      2. Sample Statement of Consent for ABC, Inc
      3. Sample Statement of Purchase
  9. Chapter 4: Employee Stock Ownership Plan Transactions and C Corporations
    1. Sample Facts—ABC, Inc. (C Corporation)
      1. Abbreviated Financial Statements
      2. FMV of Common Stock for the Purposes of an ESOP
      3. Common Entities in Transactions
      4. Example—Stock Contributed to ESOP (Capital Formation ESOP)
      5. Example—Leveraged ESOP With IRC Section 1042 Rollover
      6. IRC Section 1042 Restrictions
      7. Example—Prefunded ESOP With IRC Section 1042 Rollover
      8. IRC Section 1042 Restrictions
      9. Example—Leveraged ESOP With IRC Section 1042 Rollover and Control
      10. Example—Leveraged ESOP With IRC Section 1042 Rollover, Multiple Classes of Stock, and Control
    2. Summary
  10. Chapter 5: Employee Stock Ownership Plan Transactions and S Corporations
    1. Sample Facts—ABC, Inc. (S Corporation)
      1. Abbreviated Financial Statements
      2. FMV of Common Stock for the Purposes of an ESOP
      3. Common Entities in Transactions
      4. Example—Stock Contributed to ESOP (Capital Formation ESOP)
      5. Example—Leveraged ESOP (Paying Capital Gains)
      6. Example—Prefunded ESOP With No Bank Debt
      7. Example—Convert to C Corporation—Leveraged SOP With IRC Section 1042 Rollover and Control
      8. IRC Section 1042 Restrictions
      9. Example—Leveraged Sale of 100 Percent to the ESOP in a Single Transaction
    2. Summary
  11. Chapter 6: Advanced Employee Stock Ownership Plan Applications
    1. Mergers and Acquisitions—Buying a Target Company With Pretax Dollars
      1. Purchase of Stock
      2. Purchase of Assets
    2. Mergers and Acquisitions—Extending the Internal Revenue Code Section 1042 Rollover to a Target Company
    3. Extending the IRC Section 1042 Rollover to an Investment in Another Closely Held Company
    4. Multiple Investor ESOPs
    5. Charitable Giving and ESOPs
      1. Contributions of Closely Held Stock to Charities
      2. Charitable Remainder Income Trusts and ESOPs
    6. Summary
  12. Chapter 7: Valuation Issues and Considerations
    1. Issues Regarding ESOP-Based Valuations
      1. Identify the Client
    2. Standard of Value
      1. IRS
      2. DOL
    3. Valuation Independence and SOX
      1. Impact of SOX
      2. AICPA Newsletter: CPA Expert, Summer 2003
    4. Valuation Perspective on the Repurchase Obligation and the Put Option
    5. Valuation Report Date and Events
      1. Opinion of Value at a Point in Time
    6. Approaches to Establishing Value
      1. Initial Valuation: C Versus S Corporation Considerations
      2. Income Approach
      3. Market Approach
      4. Asset Approach
      5. Lack of Marketability Adjustment (Discount)
    7. Ownership Characteristics
      1. Minority and Control Positions
      2. Multistage Transactions
      3. Dilution Considerations and Outstanding Shares
      4. Dilution With the ESOP Contribution of Newly Issued Stock
    8. Leveraged ESOPs—Initial Valuation and Annual Updates
    9. Annual ESOP Update Issues
      1. Fluctuations in Value Between Years
      2. Valuation Methodology—Issue of Consistency
      3. Increasing Value With Time
    10. Multi-Investor ESOPs and Allocation Considerations
      1. Multiple Classes of Stock in C Corporation ESOP Transactions
    11. Practical Valuation Considerations
  13. Chapter 8: Administration and Transaction Considerations
    1. Initial Considerations and ESOP Feasibility Study
      1. Team of Advisors
      2. Team of Advisers Summary—Have a Transaction "Quarterback"
      3. Feasibility Study
      4. Informal Planning Process
      5. Written ESOP Feasibility Study
      6. Feasibility Summary
    2. Strategic ESOP Design Considerations
      1. Contribution and Addition Limits to Qualified Plans Expanded
      2. Maintaining Both an ESOP and a 401(k) Plan
      3. Creation of a Preferred Stock or Super Common Stock for the ESOP in a C Corporation
      4. Compatibility With the S Corporation Election
    3. Senior Management Compensation and Incentives
      1. Special S Corporation Considerations
    4. ESOP Trustee and Transaction Considerations
      1. Benefits of an Independent Fiduciary
    5. ESOP Fairness Opinion
      1. Fairness From Only a Financial Viewpoint
      2. Common Components of the Fairness Opinion
    6. Rights of ESOP Participants
      1. Right to Demand Employer Securities
      2. ESOP Participant Voting Rights
      3. Written Materials
      4. Dispute Settlement
      5. Diversification Requirements
    7. Stock Repurchase Obligation
      1. Practical Insights
      2. Repurchase Studies
      3. Funding the Repurchase Obligation
      4. Election: Redeeming the ESOP Stock Back to the ESOP
      5. Election: Redeeming the ESOP Stock to the Company Treasury
    8. ESOP Termination
      1. Plan Termination With Outstanding ESOP Debt
    9. Disadvantages of ESOPs
      1. Complex Regulatory Environment
      2. Fiduciary Responsibilities
      3. Initial Cost and Ongoing Expenses
      4. Repurchase Obligation
      5. Employees Fail to Understand and Appreciate the ESOP
    10. Summary
  14. Chapter 9: Financial Considerations
    1. Financing Overview for ESOPs
      1. ESOP Loan Exemption
    2. Financing an ESOP—Internal Sources
      1. Financially Successful Employer (Plan Sponsor)
      2. Prefunding the ESOP
      3. Stock Contributions to the ESOP
      4. Inside Loan From the Company to the ESOP
    3. Financing an ESOP—Seller Financing
      1. S Corporation Application
      2. C Corporation Application
      3. Leveraged QRP Solution
      4. Floating Rate Note
    4. Financing an ESOP—Third-Party Financing (Bank Debt)
      1. Historical Note—Repeal of ESOP Loan Interest Exclusion
      2. Overview of General Banking Concerns
      3. Common Loan Mechanics
      4. C Corporation ESOPs
      5. S Corporation ESOPs
    5. Summary
  15. Chapter 10: Litigation and Significant Cases
    1. The Employee Retirement Income Security Act of 1974 and ESOPs
      1. The Importance of Court Cases
      2. The IRS
      3. The DOL
    2. Significant Court Cases
      1. Court Case: Donovan v. Cunningham
      2. Court Case: Hines v. Schlimgen
      3. Court Case: Las Vegas Dodge, Inc. v. U.S
      4. Court Case: Gary L. Eyler v. Commissioner
      5. Court Case: William R. Davis v. Torvick, Inc
      6. Court Case: Delta Star v. Patton
  16. Chapter 11: Practical Considerations and Employee Stock Ownership Plan Resources
    1. Qualifying ESOP Candidates
      1. Qualities of Successful ESOP Candidates
      2. Characteristics of Less Successful ESOP Candidates
      3. Practical Insights Summary
    2. Overview of ESOP-Related Resources
      1. The EA Publications
      2. NCEO Publications
      3. The Ohio Employee Ownership Center
      4. Other ESOP Resources