ESOP Services: The Team Appoach
The Ultimate Exit Strategy and Financial Tool
Employee Stock Ownership Plans ("ESOP") are a powerful tool in today's world of corporate finance. Like any sophisticated financial tools, however, ESOPs do not fit all corporate financial structures and must be planned and structured properly, which requires deep experience in designing, implementing and valuing ESOP companies.
ATI Capital Group, Inc. ("ATICG") is a leader in the design, implementation and\or valuation of ESOPs, with over fifteen years of direct practice experience and the successful implementation of numerous plans. We have valued the stock of over one hundred ESOP companies, as well as acted as the financial advisor to the corporation. We are a member of the National ESOP Association, which serves the nation's ESOP companies and professional advisors by offering high-level educational material and symposiums, and by providing lobbying efforts in the U. S. Congress to insure passage of friendly legislation.
ESOPS can provide unparalleled financial benefits when applied properly to real-life needs and concerns within today's corporate environment. Whether reducing or elminating taxes, growing through acquisitions, building capital, planning for management succession and ownership transfer, consolidation of ownership of fractional or supper minority shares, or for reducing the cost burden of employee benefit packages, ESOPs deserve careful consideration by companies as a tool for future success and staying power.
What is an ESOP?
An ESOP is a Qualified Plan under the Employees Retirement Income Security Act of 1974 (ERISA). See Sections 401(a), 4975(e) and 501(a) of the Internal Revenue Code ("IRC") of 1986, as amended, and Section 407(d)(6) of ERISA, 1974. An ESOP is a defined contribution, tax-qualified plan that has three distinguishing features:
- An ESOP must invest “primarily” in the stock of its sponsoring company.
- An ESOP is the only qualified plan under ERISA allowed to borrow money.
- An ESOP is allowed to acquire the stock of its sponsoring Company in stages (multiple stock sales).
Having a deep understanding of these three fatures and\or requirements from a finance, accounting and tax perspective is what gives this "financial tool" its horsepower. Once the ESOP is implemented, the corporation makes tax deductible contributions to its qualified plan called an ESOP. The trust then repays the money right back to the corporation to satisfy its debt obligation to the Company (required by the DOL). This process makes the contribution tax-deductible to the company, while allowing the cash flow to come right back into the company tax free. Owners of privately held corporations can sell all or part of their stock to an ESOP for full Fair Market Value, often completely avoiding capital gains tax on the transaction.
Did you know that in addition to the principle and interest on an ESOP loan being tax deductible to the corporation, you can sell your company stock to an ESOP and pay absolutely NO CAPITAL GAIN TAX at the time of the transaction? That's right! Under IRC §1042 if you properly re-invest the proceeds from the sale of your stock to the ESOP, you can do so and defer the capital gains tax on the transaction. Proper planning allows us to turn the deferral into elimination!
Furthermore, you can actually purchase capital goods with pre-tax dollars, if properly structured through an ESOP without losing the DEPRECIATION DEDUCTION! That’s right, get up to 200% write-off for the purchase of capital goods through an ESOP.
Likewise, if you purchase a “bundle of capital goods or assets” (another Company), you can do so with pre-tax dollars if properly structured through an ESOP! That means you'll be depreciating the assets based on the asset allocation at the time of purchase, and deducting the principal and interest on the loan used to purchase the target company, thereby generating substantial corporate income tax deductions for many years after the transaction.
Lastly, did you know that you can refinance existing debt through an ESOP and then fully tax-deduct the principal and interest on the repayment of the debt from that day forward?
The tax reform act of 1997, which became law effective on January 1, 1998, made it advantageous for “S” Corporations to participate in ESOP structures. The most profound change made by Congress was the removal of Unrelated Business Income Tax (“UBIT”) on the income attributable to stock held by an employee stock ownership trust (‘ESOT”). The result is that the K-1 income attributable to stock held by the ESOT is no longer subject to any tax at any level, at any time! For example, if a company has in ESOP in place that owns 30% of the outstanding stock of the company, then 30% of the total net income is free from taxation, federal, state, corporate and personal. Likewise, if the “S” company is 50% owned by its ESOT, then 50% of the K-1 operating income is free from corporate and personal income taxes at the federal and state level. This is without limitation, so if the “S” company is 100% owned by its ESOT, then 100% of the operating income of such company is not subject to federal or state income taxes, corporate or personal.
YOU CAN HAVE A FOR PROFIT “S” CORPORATION
THAT IS NOT SUBJECT TO FEDERAL OR STATE INCOME TAX,
(CORPORATE OR PERSONAL), SO LONG AS THE “S” CORPORATION
IS 100% OWNED BY ITS ESOP!!!!
Keep in mind that ESOPs, (“C” or “S”), are not for everyone in that they are complex, but with proper planning for the “good fit” company, there is no better tool. It is important to note that there are substantial rules that must be adhered to when the Company selects the “S” Corporation ESOP, such as the anti-abuse rules under IRC §409(p), but that’s were ATICG comes in. We will guide you though the rules and regulations so you can make a reasonable, informed business decision. Whether “C” or “S”, partial or completely owned by the trust, whether capital intensive or service corporation, and regardless as to whether you have family in the business that is ready, willing and able to run the company, an ESOP may be the best corporation transition strategy available today.
Benefits for the Shareholder
- Tax-deferred (permanently deferred, if structured properly) transaction on the sale of stock to an ESOP (for owners of ‘C’ Corporation stock only).
- Seller obtains top dollar, controlling interest value on the sale of stock to an ESOP even if a staged transaction is entered into with the trust (certain temporary regulations apply).
- Shareholder can sell stock and remain in control.
- Seller obtains additional annual income due to investing pre-tax dollars.
- Seller diversifies investments (all of the eggs are no longer in the company basket).
- Seller obtains liquidity and flexibility for estate planning.
- Seller has control over the sale of his/her stock and the orderly transfer of management responsibilities.
Benefits for the Employee
Creation of a quasi-public market for corporate stock (go public internally). Employees have a 'put option' and a market for their company stock, giving them options and control which leads to increased morale and loyalty.
- Ownership of employer securities
- No payment required from employees
- ESOP loan is non-recourse to employee
- Retirement plan that directly correlates with the performance of the employees
- Put option required by law
- No fear of job loss upon sale of company
- Increased morale
- Creation of a quasi-public market for Corporate stock- go public internally. Employees have a "put option" and a market for their Company stock. Increased morale.
The fact of the matter is there are only three potential buyers for a company:
- An Individual
- Another Corporation
- A Qualified Plan (ESOP)
Benefits for the Corporation
- Corporation obtains 100% deductibility of PRINCIPAL and interest on an ESOP loan.
- Corporation can fully deduct DIVIDENDS paid to reduce ESOP debt under IRC §404(k).
- Corporation experiences increased cash flow due to the deductibility of principal on an ESOP loan.
- Collateral for an ESOP loan is created outside the corporation.
- Corporations engaging in ESOP transactions often obtain preferred terms on ESOP loans.
- The selling shareholder’s retirement is funded outside the corporation, relieving the company from the burden of funding retirement benefits.
- Corporation can often experience increased cash flow due to the possible reduction in the seller’s corporation-provided compensation.
- Ability to attract and retain productive employees.
- Creates a take-over defense by means of a friendly voting block.
- Ability to give employees equity in the company with no payment on their part, on a tax-deductible basis without transferring title of the securities to the employees.
- Corporation can refinance existing debt on a tax-deductible basis.
- Corporation can merge with or acquire another corporation using pre-tax dollars.
- Corporation can purchase capital goods using pre-tax dollars.
- In some circumstances, the corporation can recover taxes paid in previous periods.
- Corporation can increase its net worth and appraised value by rolling over existing qualified plans into an ESOP when the proceeds are used to purchase stock of the sponsoring Company.
- Creation of a quasi-public market for Corporate Stock – go public internally without the costs and liability exposure of Sarbanes-Oxley.
- Employees have a “put” option and a market for their Company stock, which has the affect of increasing employee morale.
16 Steps to a Successful ESOP
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