2015 Midwest ESOP Conference ESOP Essentials: ESOP Basics for New Participants

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1 2015 Midwest ESOP Conference ESOP Essentials: ESOP Basics for New Participants Presented by: Jim Myott, J.D., CPA Boulay PLLP Kevin Rusch, CPA, QPA Blue Ridge ESOP Associates

2 Today s Focus and Agenda Present ESOP concepts in simple terms Explain how a typical ESOP works Show sample participant statements Get your questions answered please ask questions throughout our session

3 What is an ESOP? ESOP is an acronym for Employee Stock Ownership Plan An ESOP is a qualified retirement plan (similar to a 401(k) plan) Since ESOPs are retirement plans, they must satisfy the requirements of the Internal Revenue Code and the Employee Retirement Income Security Act ( ERISA ) of 1974 Special ERISA rules unique to ESOPs include: Primarily invested in employer securities of the sponsoring company May use debt to purchase employer securities (leveraged ESOP) Enter transactions with parties-in-interest (e.g. the company, owners) Funded through pre-tax company contributions

4 What is an ESOP? Company pays costs, not employees An ESOP provides employees with an ownership stake in the company ESOP trust purchases stock on employees behalf Employees do not own stock directly Employee voting rights are normally limited to major company decisions, as required by law Plan and Trust Documents are drafted to indicate how the plan is to be administered. Participants in the ESOP are provided a Summary Plan Description (SPD)

5 ESOP Facts and Statistics There are approximately 10,000 ESOPs in place in the U.S., covering 10 million employees (10% of the private sector workforce). About 330 ESOPs - 3% - are in publicly traded companies. The overwhelming majority of ESOP companies are privately held Approximately 5,000 ESOP companies are majority-owned by the ESOP Approximately 4,000 ESOP companies are 100% owned by the ESOP While ESOPs are found in all industries, over 22% of them are in the manufacturing sector At least 70% of ESOP companies are or were leveraged, meaning they used borrowed funds to acquire the employer securities held by the ESOP trustee As small as a 15 employees and as large as several thousand employees (Source: The ESOP Association)

6 Leveraged Redemption Shareholders Stock Lender $ Company $

7 Leveraged ESOP Purchase Shareholders $ Stock Lender $ $ Company ESOP

8 How do ESOPs Repay the Loan? #3 Loan Payment to Lender Company #1 Contribution to Plan #2 Loan Payment to Company ESOP Lender

9 Eligibility Age requirement cannot exceed 21 Service requirements cannot exceed: One year of service (12 months from date of hire with 1,000 or more hours of work) Two years of service with immediate vesting Employees can be excluded, such as: Collectively Bargained Employees Non-Resident Aliens Leased Employees Contract Employees Affiliated Employees

10 Eligibility Must enter the plan the earlier of: The first day of the plan year which begins after the date the employee completes the statutory age and service requirements, or Six months following the date the employee completes the statutory age and service requirements

11 Eligibility Typical entry dates: Semi-annual Quarterly Monthly Immediate First day of the Plan Year

12 Contribution Allocations Common requirements to share in the allocation of contribution and forfeitures: 1,000 hours of service during plan year Employed on the last day of the plan year Hours and last day exceptions can be made for: Retired participants Deceased participants Disabled participants

13 Contribution Allocations Plan must have a definite allocation formula Proportionate to each participant's compensation Per capita Points allocation based on compensation and service Compensation needs to be defined for allocation purposes 1 st year compensation can be full year or from entry date

14 Contributions Types of Contributions Cash used for repurchases (recycling) of stock from participants entitled to be paid due to retirement, termination or diversification Cash accumulated in ESOP for future distributions or investment growth Loan payments on loans used to purchase company stock Shares allocated based on percentage of loan paid

15 Vesting Vesting refers to the amount of time an employee must work before acquiring a nonforfeitable entitlement to his or her benefit. Employees who leave the company before being fully vested will forfeit their benefits to the extent they are not vested in them. Vesting year of service is plan year in which employee worked 1,000 hours or more (includes years prior to entering plan)

16 Vesting 6-YEAR GRADED Years Vested % YEAR CLIFF Years Vested % More generous vesting schedule can be used.

17 100% Vested Fulfill requirements of vesting schedule Retirement Death (optional) Disability (optional) Partial plan termination Plan termination or complete discontinuance of contributions

18 Forfeitures Employee terminates employment before reaching 100% vesting Forfeiture event After 5 consecutive breaks in service Entire vested account balance distributed Forfeiture proceeds Reinstate previously forfeited balances Allocated to eligible participants Pay plan expenses

19 Distributions Forms of ESOP Distributions ESOP participants have a right to demand distribution in the form of stock (subject to put rights ) Exceptions: o Charter or bylaws restrict the ownership of substantially all outstanding employer securities to employees or to a qualified plan trust; o Banks that are prohibited from purchasing their own stock; or o Plan Sponsor is a S Corporation (although an S Corporation may still distribute stock with the requirement that it be immediately sold to the company or ESOP) Cash distributions are permitted if exceptions apply or certain assets of the ESOP are not invested in stock

20 Distributions Method of ESOP Distributions Lump Sum Installments o Over a period not exceeding 5 years o Extension for large balances Timing of ESOP Distributions Must be made available for distribution no later than o End of plan year following year of retirement, disability or death o End of 6 th plan year following year of termination for another reason (unless reemployed)

21 Participant Statement Examples Example 1 Leveraged ESOP Employee Theodore A. Bridgewater Date of Hire Entered Plan $50,000 compensation 10% ESOP contribution; 50% cash, 50% loan payment Stock value at $ 95 per share Stock value at $100 per share Stock value at $110 per share

22 2 years of service at 12/31/14 Recycling of stock for cash Stock is independently valued

23 3 years of service at 12/31/15 Recycling of stock for cash Stock is independently valued

24 Participant Statement Examples Example 2 Nonleveraged ESOP Employee Aaron C. Rogers Date of Hire Entered Plan $50,000 compensation; $25,000 eligible for % contribution in cash; all used for stock repurchases Stock Value at $ 95 per share Stock Value at $100 per share Stock Value at $110 per share

25 2 years of service at 12/31/14 Recycling of stock for cash Stock is independently valued

26 3 years of service at 12/31/15 Recycling of stock for cash Stock is independently valued

27 QUESTIONS?