ESOPs Offer Significant Benefits For Business OwnersMarch 3, 2017
Let’s say you are an owner of a successful privately-held company and you would like to cash out the substantial value reflected in your business. In addition, you would like to find an appropriate buyer for your company, a person that will carry on the business legacy you built and will continue to treat your employees in a manner similar to the way you treat them. A buyer in the form of an “employee stock ownership plan” (“ESOP”) may be the answer.
What Is An ESOP?
An ESOP is a tax-qualified retirement plan that is designed to be primarily invested in the company’s stock. Thus, since ESOPs must hold “company stock,” ESOPs must be maintained by corporations for federal income tax purposes (e.g., regular C corporations or Subchapter S corporations). LLCs and partnerships are not eligible to maintain ESOPs.
Favorable Tax and ERISA Benefits
As a tax-qualified retirement, company contributions to the ESOP, within IRS-prescribed limits, are tax deductible by the company. Moreover, ESOPs are uniquely allowed to borrow money from the company or other third parties to enable the ESOP to fund the purchase of company stock. Thus, an ESOP’s purchase of stock from a company owner can effectively be financed with fully tax deductible dollars, even the amounts applied by the ESOP to repay the principal on the loan used by the ESOP to purchase the owner’s shares.
Special ESOP Gain Deferral Rules
Special provisions in the Internal Revenue Code permit an owner (or owners) selling stock in a privately-held domestic C corporation to an ESOP to defer the recognition of the gain on the sale if certain tax law requirements are met. Such requirements include (i) the ESOP must own at least 30% of the company’s stock immediately after the sale, and (ii) the selling shareholder timely reinvests the ESOP sale proceeds in stocks and/or bonds of U.S. operating corporations. Thus, a company owner can liquidate his or her ownership interest in the company and pay no federal income tax upon a sale of stock to an ESOP, and at the same time favorably diversify his or her wealth among a portfolio of U.S. corporate stocks and bonds. In addition, the sale of stock to the ESOP effectively sells such portion of the company to the company’s employees through their participation in the ESOP, thus allowing the employees to obtain a vested equity stake in the future appreciation in the value of their company. Such “skin in the game” for employees can provide a powerful basis for increasing employee commitment and productivity for the betterment of the company and its owners.
As the above discussion indicates, the use of an ESOP to facilitate the sale of a privately-held company owner’s stock may prove to be a “win-win” result for the company owner, the company, and its employees.
Brach Eichler Benefits ReviewJanuary 26, 2017
2017 QUALIFIED PLAN LIMITS
Qualified retirement plans, such as Internal Revenue Code sections 401(k) and 403(b) plans, pension and profit sharing plans, individual retirement accounts (IRAs), and health flexible spending accounts (Health FSAs) are subject to various dollar limits on the amount of contributions that can be made or benefits that may accrue under such arrangements. Most of these dollar limits are adjusted annually by the IRS for changes in the “cost of living.”
For 2017, some of the key dollar limits affecting the above plans, IRAs and Health FSAs are as follows:
While the above benefit and contribution limits should be, as applicable, reflected in the plan documents for such plans and accounts, and in the operation of such arrangements, it is important to remember that the elective deferral and, as applicable, related catch-up contribution limits apply on an individual basis. Thus, if you change jobs during calendar year 2017 and participate in two or more employer-provided 401(k) and/or 403(b) plans, you are entitled to a maximum aggregate elective deferral and catch-up contribution limit under all such plans for 2017 of $18,000 in elective deferrals and $6,000 in catch-up contributions (i.e., one set of elective deferral and catch-up contribution limits apply per individual per calendar year).
Related Practice: Employment Services
New Fiduciary Investment Advice RuleMay 17, 2016
On April 6, 2016, the U.S. Department of Labor (“DOL”) issued a final regulation (the “New Fiduciary Rule”) that redefines and significantly broadens the scope for determining who is treated as a fiduciary as a result of the provision of “investment advice” to plans covered by the Employee Retirement Income Security Act (“ERISA”), and their plan fiduciaries, participants and beneficiaries, and individual retirement accounts (“IRAs”), and IRA owners. The New Fiduciary Rule also includes two new prohibited transaction class exemptions and modifications to other current prohibited transaction class exemptions to reflect this new expanded definition of fiduciary investment advice. This article will focus on the new fiduciary investment advice regulatory rule. A future article will address the new and revised prohibited transaction class exemptions.
Related Practice: Employment Services
Employee Benefits - Topics of InterestJanuary 4, 2016
Nonqualified Deferred Compensation Arrangements
While many may know about qualified retirement plans, such as a 401(k) plan, and the rules governing such plans, it is likely that most people are not aware of the important tax rules that govern “nonqualified deferred compensation” (“NQDC”).
Broad Scope of NQDC
The first, and perhaps most important, thing to note about NQDC is its broad scope. NQDC covers generally any promise of compensation made in one taxable year for a payment of such compensation in a later taxable year. Thus, NQDC could include compensation in the form of bonuses, elective salary deferral (outside the context of a 401(k) plan), separation or severance pay, nonelective supplemental deferred compensation, stock rights (e.g., stock options; stock appreciation rights), taxable expense reimbursements, equity-based deferred compensation (e.g., restricted stock units), and many other forms of deferred compensation that may not be labeled as “deferred compensation.”
Code Section 409A
Under Section 409A of the Internal Revenue Code, and the IRS tax regulations and other guidance issued thereunder (“Section 409A” or “409A”), rules are prescribed that must be met to avoid violations that can result in the imposition of significant federal tax penalties. The essence of Section 409A is a roadmap of rules that are designed to limit the discretion of employers and employees to change the timing and form of payment of NQDC once the legally binding promise to pay such compensation is made. It is important to note that Section 409A also covers NQDC arrangements between independent contractors (e.g., consultants) and their “service recipients.”
Compliance With 409A
In practice, Section 409A requires that NQDC either (A) satisfy an exception from 409A (e.g., special exceptions from 409A apply to (i) compensation paid within a short period after the employee (or independent contractor) “vests” in the compensation, and (ii) separation pay that is payable only upon an involuntary separation from service, is limited in amount, and is paid within a prescribed time period, or (B) complies with the substantive rules of 409A (which rules require that the compensation be paid only upon certain permitted payment trigger events and that the time and form of payment of such compensation be set forth when the deferred compensation promise is made, subject to limited opportunities thereafter to change the time or form of payment).
409A Noncompliance Penalties
A failure to comply with Section 409A will often result in income inclusion for the employee (or independent contractor) in a taxable year prior to the year the amount is otherwise scheduled to be paid, and the imposition on the employee (or independent contractor) of an additional income tax penalty equal to 20% of the amount included in income, as well as, in some cases, an interest tax penalty equal to the product of the applicable interest rate on underpayments of federal income tax plus one percentage point and the additional income tax that would have been due had the deferred compensation been included in income, as applicable, in an earlier tax year when first vested. Employers (or “service recipients” with respect to independent contractors) may be subject to tax penalties for violations of 409A due to the failure to timely report and, as applicable, withhold and remit taxes with respect to amounts included in income.
Thus, the tax stakes are high for employees (and independent contractors) who are covered by NQDC plans or arrangements that fail to comply with Section 409A. Moreover, given the broad scope of what constitutes NQDC and the need to comply with Section 409A in both form of documentation and in operation, it is strongly recommended that employees (and independent contractors), and employers (and service recipients), take all steps necessary to ensure that their NQDC plans and arrangements comply with, or are otherwise exempt from, the requirements of Section 409A.