Keys to Successful ESOP Administration

Transcription

1 Keys to Successful ESOP Administration Barbara M. Clough, QPA, QKA Director, Newport Group Barbara M. Clough, QPA, QKA Director, Newport Group Barbara Clough is a Director in Newport Group s national Employee Stock Ownership Plan (ESOP) administration and consulting practice. Barbara works closely with plan sponsors, accountants and legal experts to provide guidance on plan design, legal and compliance matters as well as IRS & DOL inquiries. Her experience includes administration, compliance and reporting for plans ranging in size from 20 to 20,000 employees for both C and S Corporations. Barbara is a leading expert on compliance matters with extensive experience in Code Section 409(p) testing. Barbara is responsible for training, mentoring and managing Newport Group s ESOP Team. She is a frequent speaker and author. Barbara is the Immediate Past Chair of the ESOP Association s Administration Advisory Committee, Board member for the National Center for Employee Ownership and ASPPA member. 1

2 ESOPs Tax Qualified Plan Must Investment Primarily in Employer Stock How does an ESOP get stock? Employer Contributions Non-Leveraged Purchase Leveraged Purchase Stock Requirements Stock must be valued by Independent Appraiser Value must be contemporaneous with purchase Value must be obtained at least annually be independent appraiser 2

3 $12.0 Million Note Payable Leveraged Loans Statutory exemption to PTE Rule 4975(d)(3) and 4975(e)(7) IF Primarily for benefit of participants Reasonable interest rate Collateral consists only of qualified employer securities Transaction Illustration XYZ $12.0 Million Cash $12.0 Million Note Payable Lender ESOP $12.0 Million Cash 60% of the Outstanding Shares Jim 3

4 Payment Company Loan Leveraged Loan Payments Lender XYZ Note Payment ESOP 1. XYZ makes a tax-deductible contribution to the ESOP 2. ESOP uses the contribution to repay its loan from XYZ 3. XYZ repays Lender Loan Payments Equal Shares Released Principal-only Method Terms of loan must require repayment within ten years Interest must follow standard loan amortization schedules Loan may not be extended beyond ten years Current Principal Payment Current + Future Principal Payments * Suspense Shares Principal and Interest Method Replace Principal above with Principal + Interest 4

5 Special Release Considerations Fluctuating Interest Rates Years that have 360 days Prepayments of Principal Loan Payment Considerations 404(a)(3) and 404(a)(9) deductions Can I really take deductions of up to 50% of eligible compensation? 5

6 Loan Payment Considerations Dividends and S-Corporation Shareholder distributions Dividends must follow the shares C Corporation dividends must be deductible under 404(k) Dividends must be reasonable Treatment of Dividends Dividends on non-leveraged shares or loans that have been paid in full CAN NOT be used for debt payment on current leveraged loans Dividends must be broken down further between allocated shares (those earmarked for individual participants) and unallocated shares (those still held in the leveraged loan) 6

7 Treatment of Dividends Dividends on allocated shares are typically allocated based on stock balances Dividends on unallocated shares are typically allocated in same manner as employer contribution (typically salary ratio) Dividend Fair Value Test Dividends must pass the Fair Value test Essentially participants must receive stock in value at least equal to the amount they would have received in cash. 7

8 Dividend Fair Value Test The gap between dividend paid and MV of shares release may be larger Various options to handle short fall Borrow from shares released on unallocated Changes allocation to be based on share balances vs. compensation May provide larger allocation to terminated employees Make an additional contribution in form of SHARES to cover shortfall May be problematic for 100% ESOPs Allocate shares pending future loan payments and release Problematic in future years as loan payments will be made but no shares will be allocated Mature ESOP Issues Repurchase Obligation How do I quantitate and plan for the future payments to plan participants? Distribution Provisions Plan Documents typically written with statutory maximum provisions Distribution Delay for Leveraged Loans Implementation of Distribution Policy 8

9 Mature ESOP Issues Have v. Have Nots The problem: All of the shares are allocated and new employees aren t reaping the benefits of employee ownership Rebalancing 9

10 Rebalancing IRS Definition: The mandatory transfer of employer securities into and out of participant ESOP accounts, usually on an annual basis, designed to result in all participant accounts having the same proportion of employer securities. Each year the plan accounts are rebalanced so that each participant has the same percentage of his/her account investment in employer stock and other investments (e.g. all participants have 90% stock and 10% cash) Rebalancing Works when plan has accumulated cash Takes stock from long-term participants for benefit of new participants Provides diversification for all participants Best when implemented early in a plan s lifetime Communication to plan participants 10

11 Rebalancing ABC Company ESOP ABC Stock Other Investments Total Trust Balances at the close of the allocation period: $ 400,000 $ 100,000 $ 500, % 20.0% Participant Balances (pre-rebalance): Participant A $ 130,000 $ 35,000 $ 165, % 21.2% Participant B $ 250,000 $ 10,000 $ 260, % 3.8% Participant C $ 20,000 $ 55,000 $ 75, % 73.3% Participant Balances (post-rebalance): Participant A $ 132,000 $ 33,000 $ 165, % 20.0% Participant B $ 208,000 $ 52,000 $ 260, % 20.0% Participant C $ 60,000 $ 15,000 $ 75, % 20.0% Rebalancing IRS Technical Assistance Memo (TAM) #4 Provision must be in plan document Typically last transaction in any allocation cycle Based on Market Value on allocation date If Plan also has Reshuffling provision those employees are excluded from Rebalancing 11

12 Reshuffling RESHUFFLING (aka Segregation/ Conversion) IRS Definition: The mandatory transfer of employer securities into or out of ESOP accounts, not designed to result in an equal portion of employer securities in each account. 12

13 Reshuffling Terminated participants receive other investments from active participants in exchange for stock Active participants receive stock from the terminated participants in exchange for the other investments Terminated participants no longer share in the investment experience of the company stock Careful consideration must be given to the investment of the terminated account balances (fiduciary concerns) Reshuffling Example ABC Company ESOP ABC Stock Other Investments Total Trust Balances at the close of the allocation period: $ 400,000 $ 100,000 $ 500, % 20.0% Participant Balances (pre-reshuffle/segregation): Active Participant A $ 130,000 $ 35,000 $ 165, % 21.2% Active Participant B $ 250,000 $ 10,000 $ 260, % 3.8% Terminated Participant C $ 20,000 $ 55,000 $ 75, % 73.3% Participant Balances (post-reshuffle/segregation): Active Participant A $ 145,556 $ 19,444 $ 165, % 11.8% Active Participant B $ 254,444 $ 5,556 $ 260, % 2.1% Terminated Participant C $ - $ 75,000 $ 75, % 100.0% 13

14 Reshuffling IRS Technical Assistance Memo (TAM) #4 Provision must be in plan document Timing Market Value to be used for Segregation May exclude certain classes of employees such as Retired, Death, Disabled Cash must be in the plan in order to segregate What happens if there is insufficient cash? BIO Phone: Barbara M. Clough, QPA, QKA Barbara Clough is a Director at Newport Group in the firm s national Employee Stock Ownership Plan (ESOP) administration and consulting practice. Ms. Clough is responsible for client relations, training, mentoring, and managing the ESOP team. Ms. Clough has worked closely with Plan Sponsors, accountants and legal counsel to provide guidance on plan design, legal and compliance matters, and DOL & IRS inquiries. She administers and provides annual reporting and compliance for plans ranging from 20 to 20,000 employees. Ms. Clough is a leading expert on compliance matters with extensive experience in Code Section 409(p) testing. Ms. Clough holds a Bachelor of Science degree from the University of Massachusetts. She is the immediate past chairwoman of The ESOP Association s Administrative Advisory Committee, past Administration Representative of The ESOP Association Interdisciplinary Committee, Vice President of Programming for The New England Chapter of The ESOP Association, frequent author and speaker at NCEO and ESOP Association conferences. Ms. Clough is a member of ASPPA, the ESOP Association and NCEO. 14