Chapter 6 - Stock Bonus Plans & Employee Stock Ownership Plans Flashcards
Define Adequate Consideration Standard
Fair market value determined in good faith.
Define Dilution
The reduction in the monetary value or voting power of an owner’s stock as a result of contributions to stock bonus plans and ESOPs.
Define Discretionary
The choice for a plan sponsor of a profit sharing plan as to the amount and frequency of a contribution
Define Disqualified Persons
Any person who owns with other family members 20% of more of the stock of the company, or in the case of someone without other family ownership, owns 10% or more of the stock of the company.
Define Diversified Investment Portfolio
An investment portfolio invested in a broad range of investment classes to reduce investment risk.
Define Employee Stock Ownership Plan (ESOP)
A qualified profit sharing plan that utilizes employer contributions to the plan to purchase the stock of the employer’s company and allocates the ownership to the plan participants.
Define Fair Market Value
The price that a willing buyer would pay to a willing seller, both having reasonable knowledge of the pertinent facts and neither under duress.
Define Leveraged ESOP
An ESOP that borrows the funds necessary to purchase the employer’s stock. The interest and principal repayments on the loan are tax deductible for the employer.
Define Net Utilized Appreciation (NUA)
The appreciation in value of employer stock after the date of contribution to the plan until the date of distribution.
Define Nonallocation Year
Any plan year of an employee stock ownership plan that holds employer securities consisting in an S corporation, and disqualified persons own at least 50% of the number of shares of stock in the S corporation.
Define Nonrecognition of Gain Treatment
A delay in the recognition of gain available to owners of a company that sell company stock to an ESOP. The transaction must meet the stated requirements of the IRC and the owner must reinvest the proceeds from the sale within 12 months of the sale into qualified domestic replacement securities.
Define Pas Through Voting Rights
The voting rights of the stock pass through from the ESOP or stock bonus plan to the participants.
Define Qualified Replacement Securities
Securities in a domestic corporation, including stocks, bonds, debentures, or warrants, which receive no more of their income from passive investments.
Define Rank-and-File Employees
The non-key, non-highly compensated employees.
Define Repurchase Option (Put Option)
An option that allows a terminating employee to receive in cash the FMV of the employer’s stock with a stock bonus plan or ESOP if the employer stock is not readily tradable on an established market. An option to sell to the employer.
Define S Corporations
Small corporations taxes as pass-through entities that cannot have more than 100 individual shareholders and have only one class of stock.
Define Stock Bonus Plan
A qualified profit sharing plan funded solely with employer stock.
Define Substantial and Recurring
IRC standard defining the frequency requirement of contributions by employers to profit sharing plans.
Why would an employer establish a stock bonus plan instead of a profit sharing plan?
Because they don’t want to take away from their cash flow to provide their employees benefits. With a stock bonus they can use shares of stock instead of cash that may or not be best used to fund an employee’s account.
What is in ESOP?
An employee stock ownership plan is a qualified plan that invests primarily in “qualifying employer securities,” typically shares of stock in the corporation creating the plan.
What requirements must stock bonus plans satisfy?
- Unlike PSPs, stock bonus participant’s must have pass through voting rights on employer stock held in the plan.
- Participants must have the right to demand employer securities on plan distributions.
- Participants must have the right to demand that the employer repurchase the employer’s securities if they are not publicly traded (the put option).
- Distributions must begin with one year of normal retirement age, death, or disability, or within five years for other modes of employment termination.
- Distributions must be fully paid within five years of commencement of distributions.
What are the advantages of a stock bonus plan?
- The FMV of the contributions of employer stock are tax deductible to the employer.
- Contributions are not required to be fixed in amount, which allows the corporation flexibility in funding.
- They promote productivity within the corporation because participants, as shareholders, have a vested financial interest in the growth and success of the corporation.
What are the disadvantages of a stock bonus plan for the employees?
- For employee, risk associated with non-diversified portfolio
- If corporation were to fail, entire value of employee retirement accounts may be lost as well as job and source of income.
What are the disadvantages of a stock bonus plan for the employers?
- Ownership and control of corporation are diluted.
- Required put option could deplete cash of the corporation.