Stock Bonus Plans and Employee Ownership Plans

Question 1

What is purpose of a leveraged ESOP?

Answer 1

Used as an exit strategy for a business owner

In many cases, for an ESOP, the principal shareholder wants out, but company can’t afford to buy him out, so company goes to a lender to help make the transaction work

Leveraged ESOP is the only qualified plan that allows for borrowing

A leveraged ESOP uses the proceeds of a bank loan to purchase company stock from the company or its existing shareholders. The sale price is established by an independent appraiser.

Question 2

Stock Bonus Plans

Answer 2

• A type of defined contribution profit sharing plan.
• Employers contribute stock to the plan.
• Contributions are discretionary, but must be substantial and recurring.
• Allocations to the plan must be nondiscriminatory.

Question 3

ESOP and stock bonus plans are what type of plans

Answer 3

They are qualified DC plans. Remember, they will be subject to same requirements as qualified plans.

Eligibility: Age 21 and one-yr. of service

Vesting 2-6 yr. graded, or 3 yr. cliff

What are the eligibility requirements for employees to participate in the plan? Employers can’t require employees to complete more than 1 year of service or be older than age 21 to enter the plan

Question 4

There are two types of qualified plans

Answer 4

Pension Plans and Profit Sharing Plans

Question 5

Net Unrealized Appreciation (NUA)

Answer 5

• Lump sum distribution of employer securities.
  
  • Usually from ESOP or Stock Bonus Plan
• Determination of NUA:
  
  • Fair Market Value at Date of Distribution
  • Value of Stock at Date of Employer Contribution = Net Unrealized Appreciation
• Important: The appreciation of employer stock is taxed as long term capital gain and the cost of contributions is taxed as ordinary income.

Tip: This is one of the three preferred tax treatments that is only available to Qualified Plans and the only one that does not require birth prior to 1/2/1936.

In Yr. of Dist - contribution taxed as ordinary income.

In Yr. of sale of employer sale - growth taxed at LT cap gains rate

ex: A company contributed $20,000 worth of stock into Steve’s Stock Bonus Plan.

• The stock is distributed to Steve 5 years later when the stock is worth $100,000
• Steve sells the stock 6 months later for $125,000.
• Tax consequences:
  
  • At Distribution: $20,000 of ordinary income
  • At Sale: $80,000 LTCG; $25,000 STCG

LTCG: Long Term Capital Gain

STCG: Short Term Capital Gain

Question 6

Stock Bonus vs. PSP

Answer 6

Question 7

Employee Stock Ownership Plans (ESOPs)

Answer 7

• An ESOP is a Defined Contribution Profit Sharing Plan, which is established as a trust.
• The participant receives allocations of the employer stock from the ESOP.
• The employer receives a tax deduction for the value of the stock contributed to the plan.

Tip: An ESOP is ideal to use for a retiring entrepreneur who wants to sell to the employees.

Question 8

Non-Recognition of Gains for ESOPs

Answer 8

In order to qualify for nonrecognition of gain treatment, the following requirements apply:

• The ESOP must own at least 30% of the corporation’s stock immediately after the sale (notice that the controlling interest may remain owned elsewhere, but if this occurs the ESOP share should have been valued using a minority share discount).
• The seller or sellers must reinvest the proceeds from the sale into qualified replacement securities (Any security issued by a domestic (American) corporation other than the company sponsoring the ESOP) within 12 months after the sale and hold such securities three years.
• The corporation that establishes the ESOP must have no class of stock outstanding that is tradable on an established securities market.

Tip: These “nonrecognition” rules are very important to know.

Question 9

ESOPS Contributions

Answer 9

Can use standard or age- based.

Can NEVER use social security integration

Question 10

Social security intergration - when can it be used?

Answer 10

We can social security integrate all profit sharing plans EXCEPT for ESOP plans and 401k, and simple ira plans (can almost always integrate employer money (like SEPs) with exception of ESOP, but not employee money)

Remember: 444 stres (none of these plans allow fo SS integration_

401k, 403b, 457 b simple IRA, sarsep, tradition ira, roth ira, ESOP, simple plan

*almost all employer plans (SEP, can use SS integration EXCEPT for ESOP

Tip: CODAs are not permitted to use Social Security integration; however the profit sharing portion of a 401(k) plan may use integration - just the deferral arrangement portion cannot.

Question 11

Important Rule!

True/False? A Qualified Participant may force investment diversification within his account during the qualified election period.

Answer 11

True.

Question 12

Put Option

*

Answer 12

The employee can require the employer to repurchase stock at the fair market value on the distribution date.

The put option reduces the employee’s risk, but increases the employer’s cash requirements.

Question 13

Stock Bonus Plans vs. ESOP

Answer 13