Employee Stock Ownership Plan (ESOP)

Transcription

1 Thebasics:TheESOPisessentiallyastockbonusplaninwhich employerstockmaybeusedforcontributions. How It Works Employercontributescompanystockorcashtotheplan. Employercontributionsaretaxdeductible. Contributionsarenottaxedcurrentlytotheemployee. Earningsaccumulateincometax-deferred. Distributionsaregenerallytaxedasordinaryincome.Distributionsmaybeeligiblefor10-yearincome averaging, 1 or,atretirementfromthecurrentemployer,rolledovertoatraditionalorarothira,orto anotheremployerplanifthatplanwillacceptsucharollover. Exceptformorethan5%owners,requiredminimumdistributions(RMDs)mustbeginbyApril1ofthe later of (a) the year following the year in which the participant reaches age 70½, or (b) the year following the year in which the participant retires. More-than-5% owners must begin to receive distributionsbyapril1oftheyearfollowingtheyeartheyreachage70½. A KSOP isanesopthatallowsforemployeedeferralsandemployermatchingcontributions. Additional Considerations Maximumannualdeduction:Upto25%ofcoveredpayroll(upto25%foraleveragedESOP)can becontributedanddeductedbythefirm. Individuallimits:For2014,theannualallocationofcontributionstoaparticipant saccountmaynot exceedthelesserof100%ofincludablecompensationor$52,000peryear.iftheplanisaksop permitting participant deferrals, participants age 50 and older may also make a $5,500 catch-up contribution. Employercontributions Mostplansarediscretionaryastotheamountthattheemployercontributes.Ifthereareprofits, theemployerisexpectedtomakesubstantialandrecurringcontributions. 2 Fora C corporation,uptoanadditional25%ofcoveredcompensationmaybecontributedand deductedifthiscontributionisusedtorepaytheprincipalofaloanusedbytotheplantoacquire employerstock.contributionsusedtopayinterestonloansusedtoacquirestockaredeductible withoutlimit. Excludingpersons:Certainpersonscanbeeliminatedonthebasisofmonthsofservice,ageand coverageinaunionplan;forexample,personsunderage21canbeexcludedfromtheplan. Investment of plan assets: Plan assets are required to be invested in employer stock with some exceptionsforthoseparticipantsnearingretirement.inaddition,assetsmaybeusedtopurchaselife insuranceinsomecircumstances. 1 Thosebornbefore1936maybeabletoelect10-yearaveragingorcapitalgaintreatment;thesestrategiesarenotavailableto thosebornafter SeeIRSReg (b)(2). A110S

2 Forfeitures:Asparticipantsleavethecompany and separatefromtheplan,thoselessthan100% vestedforfeitthatpartoftheaccountinwhichtheyarenotvested.thenonvestedforfeituresmay thenbeallocatedtotheremainingparticipants.thoseparticipantswhoremainintheplanthelongest willshareinthemostforfeitures. Partieswhicharefavored:Typically,youngerparticipantsarefavoredbecausetheyhavealonger timefortheirfundtogrow.also,theremaybesomespecialadvantagestothemajorshareholders. How Much Will There Be at Retirement Thiswilldependuponthreefactors. 1. Thefrequencyandamountofcontributions, 2. Thenumberofyearsuntilretirement,and 3. Theinvestmentreturn. The risk of poor investment returns rests upon the employee. However, if the investment results are favorable,theparticipantwillhavealargerfundatretirementage. AnExampleofWhat$10,000PerYearWillGrowto OverSeveralYearsatVariousRatesofGrowthWithoutTax 1 Years 4.00% 6.00% 8.00% 10.00% 5 $54,163 $56,371 $58,666 $61, $120,061 $131,808 $144,866 $159, $200,236 $232,760 $271,521 $317, $297,781 $367,856 $457,620 $572, $416,459 $548,645 $731,059 $983, $560,849 $790,582 $1,132,832 $1,644, $736,522 $1,114,348 $1,723,168 $2,710,244 Top-Heavy Plans Ifmorethan 60%oftheplanassets areallocatedtokey employees, 2 theemployermustcontributeat leastasmuchfornon-keyparticipantsasitdoesforkeyemployees.thisrequirementappliesonlytoa contributionofuptothefirst3%ofincludablecompensation(higherinsomeinstances). How ESOPs Differ from Stock Bonus Plans UnderanESOPtheparticipantshavetheabsoluterighttodemanddistributionofcompanystock. The plan may repurchase the distributed shares of stock but is not required to do so; only the employerissorequired. 1 Theratesofreturnusedinthisillustrationarenotindicativeofanyactualinvestmentandwillfluctuateinvalue. 2 A key employeeissomeonewho,atanytimeduringtheplanyearwas:(1)anofficeroftheemployerwhosecompensationfrom the employer exceeded $170,000; or (2) a more than 5% owner; or (3) a 1% owner whose compensation from the employer exceeded$150,000. A110S

3 Theplanmustpasscertainvotingrightsthroughtotheparticipants.Ifthestockisnotpubliclytraded orisrestricted,theparticipantorhisorherheirsmusthavetherighttoofferthestockforsaletothe employer. Theplanmay borrowmoneyfromabanktopurchasestock,withtheemployerguaranteeingsuch loan,withoutitbeingconsideredaprohibitedtransaction. Theplanmayborrowmoneyfromaprohibitedpersonwithoutincurringanypenalty. TheplanmaynotbeintegratedwithSocialSecurity. Whereasastockbonusplanisnotrequiredtoinvestinemployersecurities,anESOPmustinvest primarilyinemployersecurities,totheextentthatemployerstockisavailable. Theemployercancontributecompanystockdirectlytotheplan. 1 Theplanmaypurchasethesecuritiesontheopenmarketforpubliccompanies,fromthecompany itselforfromtheshareholders. Theemployercancontributeanddeductupto25%ofcompensationforaleveragedESOP,whichis repayingloanprincipal.inaddition,itcanmakedeductiblecontributionstopayinterestontheloan usedtopurchasesecurities. Advantages to Employer A. Contributionsaretaxdeductible. B. Contributionsandcostsaretotallyflexible,subjecttorequiredloanpayments. C. Theplaniseasytounderstandbytheemployees. D. Itcanprovideemployeeswithpermanentlifeinsurancebenefitsthatneednotexpireorrequire costlyconversionatretirementage. E. Since all or substantially all of the assets may be invested in employer s stock, this is a good methodforraisingadditionalcapitalwithoutgoingtothemarketplace. F. Ineffect,thecorporationcanraisecapitalwithdeductiblecontributionstoitsplan. G. Stock,ratherthancash,canbecontributedtotheplan. H. AnESOPmaybeusedtofacilitatethebuyoutofastockholder. I. Dividends paid on stock owned by the ESOP may be deducted if, in accordance with plan language,severalrequirementsaremet. J. Ineffect,boththeinterestandprincipalofloansaremadeonadeductiblebasis. K. If former participants do not provide the plan with distribution instructions, the plan may automaticallydistributeaccountslessthan$5,000.inthecaseofaplanthatprovidesforsuch mandatory distributions, the plan must automatically roll an eligible distribution amount that exceeds $1,000 to a Rollover IRA in the former participant s name. A plan may allow direct rolloversoflessthan$1,000. Advantages to Employees A. Annualemployercontributionsarenottaxedtotheparticipant. B. Earningsontheaccountarenotcurrentlytaxed. 1 However,itmaybebettertocontributecashandthenhavetheplanpurchasestockfromtheemployer.Thevaluationofstock directlycontributedtotheplanmaybechallengedbytheirs.contributingcashclearlyestablishesthevalueofthecontribution. A110S

4 C. Special treatment of unrealized gains upon the distribution of stock permits significant tax deferral. D. Participants may also have a traditional, deductible IRA (subject to certain income limitations basedonfilingstatus),atraditional,nondeductibleiraorarothira. E. Thereistheabilitytopurchasesignificantpermanentlifeinsurance,whichisnotcontingentupon thecompanygroupinsuranceprogram.purchaseoflifeinsurancewillgeneratetaxableincome totheemployee. F. Youngeremployeescanaccumulatealargerfundthanwithadefinedbenefitplan. G. The forfeited, unvested portion of accounts of former participants is allocated to the active participants accounts.thiscanhaveamajorimpactonthefuturebenefits. H. Employeeparticipatesinemployer sgrowth. I. Apotentialmarketiscreatedfordeceasedowner sstock. J. Atdistribution,thegainonthestockisnottaxeduntilitissold. K. TheESOPcanprovidesignificantestateplanningbenefitsforshareholders L. ThegainonthesaleofemployersecuritiestotheESOPcanbedeferredundercertainsituations. M. Participant may borrow from the plan within certain guidelines if provided for in the plan documents. N. ERISA and federal bankruptcy law provide significant protection from creditors to participant accountsoraccruedbenefitsintax-exemptretirementplans. O. Effective July 1, 2012, plan sponsors are required to provide participants in self-directed plans with expandedinvestmentfeeand performancedata.thisadditionalinformationis intendedto aidparticipantsinmakingbetter-informedinvestmentchoices. Disadvantages to Employer A. TheESOPwillgenerallynotproduceaslargeofacontributionanddeductionforolderemployees aswilladefinedbenefitplan. B. Deductiblecontributionlimitsaresetat25%ofcoveredcompensation. C. Certainvotingrightsmustbepassedthroughtotheparticipants. D. AnESOPcanbecostlytosetup.Ongoingadministrationcanalsobeexpensivebecauseofthe needtohavethestockvalueappraisedeachyear. E. Futurerepurchasesmaynotcomeataconvenienttimeandmustbemadewithafter-taxdollars. Thiscouldplaceafinancialstrainontheemployer. F. Effective July 1, 2012, if a plan gives participants the right to direct any investments, plan sponsorsmustprovideparticipantswithexpanded,standardizedinvestmentfeeandperformance information.failuretocomplywiththeseerisarequirementsmayresultsinabreachoffiduciary duty to plan participants and the loss of ERISA Section 404(c) protection (meaning the plan fiduciariesmaybeheldresponsiblefortheresultsoftheparticipants owninvestmentchoices). A110S

5 Disadvantages to Employees A. Thereisnoguaranteeastofuturebenefits. B. Investmentrisksrestontheparticipant. C. Thereisnoassuranceastothefrequencyandamountofemployercontributions. D. Olderparticipantsmaynotreceiveasgreatofabenefitaswithadefinedbenefitplan. E. Thevalueofcloselyheldstockmaybedifficulttodetermineatretirementage. F. Ifthefounderorkeypeopledie,retireorterminateemployment,thecompanystockmaybeworth verylittle. G. Thecompanymaynotbefinanciallyabletorepurchasethestock,eventhoughrequiredtodoso. H. Iftheemployer sstockisdepressedinvalueatretirementtime,therecouldbeasignificantloss I. intheretirementaccount. Boththeparticipant scurrentlivelihoodandretirementsavingsaredependentontheemployer s ongoingviability. A110S