ESOPs 101: ABCs of ESOPs for Employee Owners

Transcription

1 ESOPs 101: ABCs of ESOPs for Employee Owners 17 th Annual Ohio Employee Ownership Conference April 11, 2003 Akron, OH Pete Shuler (614) Member Horwath International Copyright 2003, 1

2 What is in an ESOP? Employer Stock ESOPs must invest primarily in employer stock Cash Other Investments Generally money market funds or conservative mutual funds All of these assets are held in the ESOP Trust Except suspense account shares, all are allocated to participants account These assets enter the ESOP via: Stock purchases/sales using cash in ESOP or borrowed cash Cash and stock contributions from the employer Earnings on cash and stock (dividends, interest, etc.) Member Horwath International Copyright 2003, 2

3 Allocations Cash and/or stock contributions, released shares, forfeitures Generally allocated based on relative compensation but can use other nondiscriminatory formulas: service, equal amounts Earnings Allocated dividends/s-corp distributions Held in accounts, reinvested in stock, passed-through to participants, used to repay the ESOP loan (dividends only, not S-Corp distributions) Suspense account dividends/s-corp distributions Used to repay loan or can be allocated to participant accounts Shares released allocated based on compensation or account balance Interest and Other Income Generally allocated based on relative account balances Member Horwath International Copyright 2003, 3

4 Allocations - Examples Contributions, forfeitures, released shares Eligible Participant Wages % of Total Wages Contribution Brown $30,000 30% $3,000 Smith $40,000 40% $4,000 Jones $30,000 30% $3,000 Totals 100% $ Member Horwath International Copyright 2003, 4

5 Allocations - Examples Dividends/S-Corp Distributions Participants with Balances 1/1/02 Stock Balance % of Total Stock Balance Dividends/S- Corp Dist. Brown 3,500 35% $350 Smith 2,500 25% $250 Jones 4,000 40% $400 Totals 100% $1,000 Member Horwath International Copyright 2003, 5

6 Leveraged ESOP - Initiation Lender (1) Note Payable (1) $1,000,000 ESOP (3) Unallocated Stock 100% (2) $ (2) Stock Shareholder Allocated Stock 0% (1) Lender makes a 10-year loan to the ESOP for $1,000,000. (2) ESOP purchase shares from shareholder(s). (3) When the stock is purchased it is held by the ESOP, but is not allocated to the participants. Member Horwath International Copyright 2003, 6

7 Leveraged ESOP Year 1 Lender (2) Debt Payment ESOP Unallocated Stock 90% (1) Contribution (3) Stock is allocated to participants Company Allocated Stock 10% (1) The Company makes a tax deductible contribution to the ESOP. (2) The ESOP make its debt payment to the lender. (3) Stock is released from suspense (and as collateral) and allocated to participants as debt is repaid. Assuming 10% of the payments are made, then 10% of the stock is allocated to participants. Member Horwath International Copyright 2003, 7

8 Share Release Calculations Principal-only Method Current Principal Payment Current + Future Principal Payments * Shares in Suspense Principal-and-Interest Method Current P&I Payments Current + Future P&I Payments * Shares in Suspense Member Horwath International Copyright 2003, 8

9 Share Release Example (P-only method) principal payment $1,000,000 current+future principal payments * 100,000 shares in suspense = share release Member Horwath International Copyright 2003, 9

10 Share Release Example (P-only method) Year Principal Payment Share Release Suspense Account 0 100, , , , , , , , , Totals $1,000, ,000 Member Horwath International Copyright 2003, 10

11 Vesting Determines amount terminated participants will receive Participants generally earn one Year of Vesting Service for each plan year in which they work at least 1,000 hours Vesting Schedule connects Years of Vesting Service to Vested Percentages Years of Vesting Service Vested Percentage 0% 20% 40% 60% 80% 100% Member Horwath International Copyright 2003, 11

12 Vesting Three types: Immediate Cliff Graded Generally, balances become 100% vested, regardless of Vesting Years of Service, upon: Retirement, Death, Disability Vesting Percentage * Ending Account Balance = Vested Balance. This is the amount that can never be taken from the participant Member Horwath International Copyright 2003, 12

13 Distributions Payment of vested ESOP accounts to or on behalf of participants or their beneficiaries Form Cash or stock Participants have right to demand stock distribution, unless: Corporate by-laws prohibit; S-Corp; certain banks If you receive a distribution of privately held stock, you have the right to put that stock back to the company Single payment or installments Installments cannot generally be stretched over more than 5 years Lump sum or Rollover Incur income taxes on lump sum If under 59½, incur 10% penalty on lump sum Member Horwath International Copyright 2003, 13

14 Distributions Timing ESOP participants have the right to elect distribution within: One year after death, disability, or retirement One year after 6th plan year following other separation Distributions may be postponed until ESOP acquisition loan is fully repaid Cannot delay retirement distribution, diversification, or RMD Delay only applies to shares purchased by that loan Within these statutory requirements, Plan Sponsor has flexibility in setting distribution timing Member Horwath International Copyright 2003, 14

15 Mechanics of Distribution Cash Distribution Vested shares are sold to: the external markets - NYSE, NASDQ, AMEX, OTC, etc. the Company, or the ESOP at the most recent Fair Market Value to generate cash for the distribution Participant receives these sale proceeds plus vested cash and other investments If company is privately held and stock is sold to company, valuation must be updated at time of sale Member Horwath International Copyright 2003, 15

16 Mechanics of Distribution Stock Distribution Cash in participant account is used to purchase as many whole shares as possible Vested shares are transferred to name of distributee Value of vested fractional shares is paid in cash Combination stock and cash distributions Generally, vested stock account is paid as stock, vested cash account as cash Member Horwath International Copyright 2003, 16

17 Put Option Definition: In general, the contractual right to sell a security at a set price/time With regard to ESOP's: Seller is the distributee Buyer is the Company (ESOP can step in and buy the stock) Price is the latest FMV Privately-held companies that allow stock distributions must offer put options Member Horwath International Copyright 2003, 17

18 Required Minimum Distributions Who Receives RMD s? Participants who have attained age 70½ AND either of the following: Participant is terminated from employment; or Participant is a 5% owner Attribution rules of Code Section 318 apply If RMD s begin due to 5% ownership, then RMD s continue even if ownership changes Plans may allow non-5% owners who turn 70½ and who are not terminated to receive RMD s Member Horwath International Copyright 2003, 18

19 Diversification Allows participants to reduce investment risk by spreading investments around as they approach retirement Participants age 55 or older with 10 years of participation must be permitted to diversify a certain percentage of their post-86 stock account for six years after becoming eligible: First 5 years: May diversify up to cumulative 25% of these shares Sixth year: May diversify up to cumulative 50% of these shares Three mechanisms for diversification: 1. Distributing funds directly to the participant 2. Transferring funds into IRA or employer s 401(k) plan 3. Offering at least three investment options in the ESOP (generally not recommended) Member Horwath International Copyright 2003, 19