Winter 2011
Focus On Employee Stock Ownership Plan
Independent Financial
Adviser Issues
Editor for This Issue: Malcolm ("Mike") R. Hartman
ESOP Independent Financial Adviser Insights
Thought Leadership Article:
Sale of an ESOP Sponsor Company: Questions of Time, Money, People, and the Law
Randolph R. Smith Jr., Esq.
When a closely held business owner sells his stock to an ESOP, he may
believe that this will be his last corporate transaction. Often, however, and
particularly with successful ESOP companies, potential buyers come calling. This
discussion explores the processes by which ESOP companies manage a possible sale to a
third party, including the roles of the board, the ESOP trustee, and company management.
It also considers what documents may be involved in such a sale, including the fairness
opinion provided by the ESOP's independent financial adviser.
Standing at the Crossroads: An Integrated Approach to the ESOP Repurchase
Obligation
Michael J. McGinley
This discussion outlines some of the fundamental principles of an
employee stock ownership plan (ESOP) and presents a framework for analyzing the employer
corporation stock repurchase obligation. The ESOP repurchase obligation has several
important interrelated variables that require a comprehensive plan encompassing five
important factors: Strategy of the corporation, The valuation, Actuarial variables,
Repurchase funding sources and mechanics, and Sustainability considerations. This "STARS"
framework is designed to promote dialogue and coordination between the sponsor company
management, the ESOP trustee, the ESOP legal counsel, and the valuation analyst. This
discussion describes these repurchase obligation factors and explores how these factors
affect each other.
The ESOP Feasibility Study
C. Ryan Stewart
An ESOP feasibility study is an important first step in the process
of establishing an employee stock ownership plan (ESOP) in a qualifying employer
corporation. Such a study provides useful information to shareholders who are considering
selling shares to an ESOP and to employer corporation managers. This information allows
these parties of interest to decide whether or not an ESOP employer stock purchase
transaction is an effective strategy for achieving their various objectives. ESOP
feasibility studies can be very different depending on the situation. However, most ESOP
feasibility studies contain basic elements that should be addressed in order (1) to
provide meaningful information to all parties and (2) to avoid costly mistakes that could
impair the long-term success of the ESOP.
Tax Increases and the ESOP Alternative: Motivation for Close Corporation Owners
David Burdette
Significant increases in capital gain tax rates are expected in 2011. An employee stock
ownership plan (ESOP) continues to be an attractive exit vehicle that allows the closely
held business owner to sell his or her close corporation stock to the company employees.
If properly structured, the ESOP employer stock purchase transaction provides a tax-
advantaged structure related to the sale of the employer corporation stock. With proper
structuring, an ESOP can accomplish a tax-advantaged ownership transition for the close
corporation owners. At the same time, the ESOP purchase of the employer corporation stock
typically provides an economic incentive to the company's employees.
Retained
Shareholder/Executive Reasonableness of Compensation ESOP Sponsor Company
Robert F. Reilly, CPA
An otherwise profitable closely held C corporation may be able to
minimize its federal income tax liability if it pays a salary or bonus to its
employee/shareholders in an amount sufficient to "absorb" all of the taxable income.
Whether the C corporation distribution is a salary or a dividend, all such distributions
are taxable as ordinary income to the employee/shareholder. However, employee salary or
bonus payments are tax deductible to the C corporation. In contrast, shareholder
dividends are not tax deductible to the C corporation. So, the taxpayer corporation can
reduce its federal income tax expense by characterizing employee/shareholder
distributions as salary/bonus rather than as dividends. Accordingly, the Internal Revenue
Service often challenges the reasonableness of employee/shareholder (particularly
controlling shareholder) compensation during the audit of the closely held C corporation.
This discussion summarizes the conclusion of a relevant recent Tax Court judicial
decision-with an emphasis on what is called the independent investor test of assessing
the reasonableness of employee/shareholder compensation.
Quan v. Computer Sciences Corporation: The 9th Circuit Adopts the Moench Presumption
in Favor of Plan Fiduciaries
Katherine Gilbert
This discussion reviews the recent Quan v. Computer Sciences
Corporation judicial decision. In that decision, the U.S. Court of Appeals ruled in favor
of plan fiduciaries. In addition, this discussion summarizes the "Moench Presumption" and
describes the Appeals Court decision to adopt that presumption.
Best Practices
The ESOP Trustee's Independent Financial Adviser Due Diligence Selection Process
Malcolm ("Mike") R. Hartman
For most employee stock ownership plan (ESOP) sponsor companies, the
selection of the ESOP financial adviser has typically been an informal process. In the
past, little thought was put into documenting the process by which a particular financial
adviser firm was selected. With many sponsor companies experiencing decreases in employer
stock value as a result of the recent recession, it is more important to document the
qualifications of the ESOP financial adviser firm. This discussion uses a questionnaire
developed for sponsor companies that are installing an ESOP. The purpose of the
questionnaire is to evaluate potential ESOP financial adviser firms. This discussion also
comments on the most important information that should be considered in the independent
financial adviser selection process.
Valuing Stock Appreciation Rights (SARs) in ESOP Sponsor Companies
Steve Whittington
Stock appreciation rights (SARs) are used in conjunction with ESOP
stock purchase transactions as an incentive plan for key executives (including the
selling shareholder). It is important for the ESOP financial adviser to understand (1)
what SARs are and (2) how SARs affect the value of the employer corporation stock at the
outset of a stock purchase transaction. It is also important for the ESOP financial
adviser to understand how SARs may affect future employer corporation stock
valuations.
Reconciling the
Current Employer Stock Valuation with Prior Stock Valuations
Malcolm ("Mike") R. Hartman
The stock of closely held ESOP sponsor companies must be valued at
least annually. In this valuation process, valuation analysts (and other interested
parties) often consider how the annual employer stock value conclusions compare year to
year. The U.S. Department of Labor, in its audits of these plans, pays close attention to
how the employer stock valuations change from year to year, in terms of both value
conclusions and valuation methodology. This discussion summarizes the need for the ESOP
financial adviser to carefully document the yearly employer stock valuation changes. And,
this discussion suggests financial adviser procedures for such documentation.
The Offer in Compromise Program May Offer Tax Relief to Business and Individual
Taxpayers
Robert F. Reilly, CPA
An offer in compromise (OIC) is an agreement between the taxpayer and
the Service. In this agreement, the Service accepts a payment to satisfy the taxpayer's
liability of less than the full tax amount owed. Of course, there are numerous conditions
related to the Service acceptance of a taxpayer OIC. And, there is a somewhat burdensome
process associated with the taxpayer OIC application. This discussion summarizes the OIC
application process from the perspective of a business or individual taxpayer. This
discussion assumes that the taxpayer simply does not have the cash resources available to
pay its federal tax liability.
The APA Application Process and Intercompany Transfer Price Considerations
Robert F. Reilly, CPA
Domestic taxpayer corporations that transfer tangible property (e.g., inventory),
intangible property (e.g., trademarks), or services with controlled foreign affiliates
must comply with the statutory arm's-length price (ALP) intercompany transfer price
requirements. In order to avoid surprises on audit (and statutory penalties), many such
taxpayer corporations have entered into an advance pricing agreement (APA) with the
Internal Revenue Service. This discussion summarizes (1) the taxpayer procedures in the
APA application process and (2) some of the taxpayer management considerations related to
the APA application.
NOL Carryforward Use Limitation After the Ownership Change of a Multiple Stock Class
Corporation
Robert F. Reilly, CPA
In recent years, many taxpayer corporations have accumulated net operating loss (NOL)
carryforward income tax benefits. Internal Revenue Code Section 382 limits the taxpayer
corporation's use of the NOL tax benefit when there is a change of ownership. Some change
in ownership transactions (e.g., mergers and acquisitions) are obvious. Other change in
ownership transaction (e.g., private equity investments, debt private placements with
equity conversion features) are less obvious. This discussion summarizes some of the
current valuation rules related to an ownership change in NOL corporations that have
multiple classes of stock outstanding.
Hotel Valuation Myths and
Misconceptions Revisited
David C. Lennhoff and Heather Reichardt
This discussion summarizes the "whats and whys" of hotel intangible property
allocations. And, this discussion reviews some of the recent judicial precedent related
to the topic. This discussion will also clarify some of the misunderstandings that have
developed about the withdrawal of the Appraisal Institute continuing professional
education course, Separating Real and Personal Property from Intangible Business Assets
(Course 800). Additionally, this discussion describes the importance of understanding the
relationship between real estate and personal property (both tangible and intangible
personal property) for a valuation engagement that concludes the market value of the
hotel real estate only. Such a valuation engagement typically starts with the income (or
the value) of the total operating assets of the hotel going concern business.
Forethoughts/About the Editor
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