The One-Stop ESOP Blog

LaRue’s Impact on ESOP Litigation: Cook v. Campbell Analysis

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Thu, 07 Aug 2008 17:28:00 +0000

We have extensively discussed LaRue v. DeWolff, Boberg & Assoc. Inc., No. 06-856 (Feb. 20, 2008). We have also discussed Cook v. Campbell, 482 F. Supp.2d 1341 (M.D. Ala. 2007), one of the first cases to consider LaRue's impact on individual claims involving an ESOP. The district court case rejected the attempt to revive a fiduciary breach case. Alabama District Court Rejects Application of LaRue in ESOP Participant Suit provides a detailed analysis of the case and some important takeaways:

The Cook decision is important in a post-LaRue world because of the careful distinctions that the district court has drawn between 401(k) plans and ESOPs, essentially treating ESOPs more like defined benefit plans subject to the Supreme Court's prior holding in Russell, which requires that damages in ERISA cases flow through the plan for the benefit of all plan participants. The decision is also encouraging as it shows that at least one court has not interpreted the LaRue decision to be as broad as many have opined that it would be.

ESOPs and Employee Ownership in 20 Years

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Thu, 07 Aug 2008 01:58:00 +0000

The latest Employee Ownership Blog post, Future of ESOPs, contains a discussion of where the ESOP industry sees ESOPs and employee ownership in twenty years:

With the global economy, business practices are changing fast and companies that have an advantage over their competitors are going to flourish. An ESOP will be a competitive edge.
With education of business leaders and owners, we will begin to see more ESOP companies as people realize the potential employee ownership can bring to the company.
Companies understand that employee ownership is a performance booster and will begin using it to make the company more competitive here at home and abroad.
Universities will take the lead in research efforts and redefine the way capitalism works using employee ownership as the model.
Models of employee ownership will become more diverse as well as more common in the next 20 years.
Government relations efforts are now more important than ever and we need to stay on top of the game.

Detailed Look at Florida's Purchase of 187,000 Acres of U.S. Sugar Land

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Thu, 07 Aug 2008 01:49:00 +0000

U.S. Sugar's sweet deal provides a detailed look at Florida's Purchase of the 187,000 Acres of Land Owned by U.S. Sugar Corp., including a review of the outstanding U.S. Sugar ESOP litigation:

The company is privately owned, so valuing it is tough, as there is not a public market in the company's shares. The company is controlled by the Charles Stewart Mott Foundation and its benefactors, including the longtime chairman of the company, William S. White, who is married to Mott's granddaughter. Even though the Foundation owns just 19 percent of the shares, it controls the complicated process of picking the board of directors and therefore keeps control within the Mott family. Employees own 38 percent of U.S. Sugar, through an Employee Stock Ownership Plan (ESOP) started in the 1980s.

One indication of a value for the company, then, is what it has paid employees who retire and cash out their ESOP shares. And that value is at the heart of a federal lawsuit now being contested in West Palm Beach.

Some former employees maintain they were low-balled by the company when they were paid $180-$204 a share over the past five or six years. Especially since, unknown to them at the time, a suitor was offering U.S. Sugar's board much more. Nashville banker, agriculturalist and investor Gaylon Lawrence twice in the past three years offered to pay $293 a share for the sugar company. And he thought he had a deal; in August 2005, according to the federal lawsuit, Lawrence reached an agreement with U.S. Sugar's then-CEO, Robert Dolson, for the $293-a-share purchase -- which the lawsuit calls "an extraordinarily valuable offer" that was 50 percent higher than what employees were being paid for their shares and 91 percent higher than the shares' fair market value that some charity shareholders declared in IRS filings.

U.S. Sugar's board apparently didn't appreciate the offer, according to the lawsuit. Suddenly, Lawrence found Dolson out of the picture, suddenly retired with an unexpected $10 million payment from the board. White took over negotiations and in 2006, the board voted to reject the offer, which Lawrence repeated in 2007 with the same result.

The employees' lawsuit portrays the company as buying up their shares at rock-bottom prices and then retiring those shares, increasing the size of company insiders' holdings without having to buy a single share personally. As mechanization replaced the need for employees and those workers' shares were retired, the Mott family's holdings became more and more valuable. Just in time for the state's offer of $350 a share.

The article also contains comments from Corey Rosen, executive director of the National Center for Employee Ownership (NCEO). He notes that since the ESOP owns a minority interest, the value is going to be less than that of a controlling interest. He also discusses the outstanding litigation and whether the state is overpaying for U.S. Sugar:

Rosen said the lawsuit over the value of the ESOP shares is pretty typical for ESOP litigation and that it will be very hard to win for the employees. He also said it is very difficult to tell if, based on the company's own valuation of shares for employees, whether the state is overpaying for U.S. Sugar.

"It's a complicated, detailed process to wade through all the financials," he said. "It's hard to say on its face did the state pay too much, even though there had been other lower offers for the company."

S ESOPs Create More Revenue for the Treasury, Price Protection PLR

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 06 Aug 2008 13:35:00 +0000

The July 31, 2008 Employee Ownership Update is online and discusses the following:

University of Pennsylvania Paper Finds S Corporation ESOPs Help Employees, Employers, and Taxpayers
IRS Allows Price Protection for S Corporation ESOPs
IRS/Treasury Release Proposed ESPP and Incentive Stock Option Regulations
New FASB Staff Position on Dividends or Dividend Equivalents in Share Plans
Are You an Inner City 100 Company?
Ownership Thinking Conference September 18 and 19

The Update discusses how a recent study of S Corp ESOP Legislation Benefits and Costs found that S ESOPs are a net gain for taxpayers:

The increased performance of ESOP companies, plus the fact that foregone taxes on earnings are ultimately paid by employees when they start to take benefits out some time after termination, mean that S ESOPs are a net gain for taxpayers. In addition, when employees do pay tax on their distributions, they pay on the basis of (generally) appreciated stock, with part of that appreciation due to the company's ability not to pay taxes in the interim. Given assumptions about their tax rates, the authors conclude that, on balance, the Treasury is likely to end up with more revenue this way than if the income was taxed earlier.
The Update also discusses private letter ruling (PLR) 200827008 and the reason that ESOP companies enter into a Price Protection/Floor Price Agreements:

Many ESOP companies have multiple ESOP transactions. In some companies, after the first purchase of shares, often 30% to 50%, a second transaction is done to buy more shares. Other companies that are 100% ESOP-owned do additional leveraged transactions to acquire other companies. In either case, the new debt taken on can lower the price of the shares already in the plan. To deal with this, many ESOP companies offer some kind of price protection for existing participants. Sometimes that is limited to people over a certain age and/or to people getting distributions in the next x number of years. A floor price is set, and the company makes up the difference, if any, when the distribution is made.

It also discusses IRS Treasury Regulation - REG–106251–08 - Employee Stock Purchase Plans Under Internal Revenue Code Section 423 and FASB Staff Position (No. EITF 03-6-1), Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities.

Bear Stearns ESOP Litigation Update

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 05 Aug 2008 01:52:00 +0000

The cases against Bear Stearns provides an update on more than 20 lawsuits related to the Bear Stearns transaction, including litigation from former participants in the ESOP:

Former employees vs. Bear

A handful of former employees who were investors in the Bear Stearns' Employee Stock Ownership Plan (ESOP) allege that senior Bear executives, among others, breached their fiduciary duties by failing, among other things, to prudently manage the ESOP's investment in Bear stock and inform employees about the risk of that investment.

S Corp ESOP Legislation Benefits and Costs

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 05 Aug 2008 01:14:00 +0000

Study: S ESOP Companies Create Jobs and Savings for Workers and Have Higher Productivity, Profitability, Job Stability, and Job Growth discussed a new study that found that S ESOPs create new jobs and savings that would not have otherwise been earned. Here is the abstract for S Corp ESOP Legislation Benefits and Costs: Public Policy and Tax Analysis:

Samuel Zell's acquisition of the Tribune Company in December 2007 using an S corporation employee stock ownership plan (S ESOP) brought S ESOPs to national attention. An S ESOP is a trust that holds shares of an S corporation (a closely held corporation whose shareholders are taxed on a pass-through basis similarly to partners in a partnership) for the benefit of the corporation's employees. S ESOPs, which have only existed since 1998 are not as well known as C ESOPs, an ESOP that holds shares of a C corporation (a separately taxed corporation). Enron, Polaroid and United Airlines, all of which had ESOPs when they went bankrupt, were C corporations.

Perhaps because they have only existed for ten years, little academic attention has focused on S ESOPs. In this paper we draw on the extensive existing employee ownership literature to describe the benefits and costs to employees, to firms and to society at large from the legislation that authorizes S ESOPs, and, where possible, we quantify these costs and benefits. We estimate that annual contributions to S ESOPs on behalf of employees total $14 billion, which represent additional compensation that would not have been paid without an ESOP. Annual gains attributable to increased job stability also save employees approximately $3 billion annually. Accumulated stakes, which are essentially forced savings and usually do not displace other savings, lead to additional annual accruals of $34 billion. Employers pay for ESOP contributions out of firm-level productivity and sales gains of $33 billion annually attributable to employee ownership. We estimate that one quarter of the annual gain, $8 billion ultimately goes to the federal treasury, which thereby also benefits from the adoption of S ESOPs.

The working paper covers the following:

The History of ESOPs and S ESOPs
Methodology
Benefits and Costs to Employees from ESOP Adoption
- S Corp ESOP contributions
- Accruals on equity stakes in company stock
- Employee ownership is associated with greater employment stability
- Employee ownership is associated with (mildly) increased job satisfaction and increased organizational commitment, identification, motivation, and workplace participation
- ESOPs and financial risk
Benefits and Costs to Firms and from ESOP Adoption
- Shareholder return is higher for employee owned firms than for comparable firms
- Employee ownership leads to increased productivity and profitability
- Employee ownership leads to increased sales and employment growth
- Employee-owned firms survive longer than comparable firms
Societal Costs and Benefits of Employee Ownership

Consequences to the US Federal Treasury
Tax Treatment of S ESOPs
The Tax Advantages and Disadvantages of S ESOPs
An S ESOP does not affect the amount of taxable income
ESOPs defer employee tax without affecting employer deduction timing
S ESOPs increase tax collections because productivity gains are taxed
Society-wide economic benefits attributable to S ESOPs
Social benefits of employee ownership

Summary
References
Appendices

Appendix A. Enhancements and Modifications of ESOP Tax Incentives
Appendix B. Sensitivity Analysis of our Estimates
- Attributes and Extent of S ESOPs and C ESOPs
- Contributions
- S ESOP firm level productivity gains and profits from increased sales
Appendix C. Sources of additional information about ESOPs and Employee Ownership

UPDATE 8/6/08: The study results are discussed in S ESOPs Create More Revenue for the Treasury.

Price Protection/Floor Price Agreements, PLR 200827008 Analysis

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 04 Aug 2008 06:00:00 +0000

What is a price protection or floor price agreement?

When an ESOP borrows money, the debt and related interest expense taken to finance the shares is an additional liability of the company. Although this liability will be partially offset by the tax benefits of an ESOP, it will still reduce the post-transaction value of the company. This temporary reduction in value will get smaller as the loan is repaid.

When an ESOP enters into a second stage transaction (a.k.a. any purchase after the initial one), the value of the company will experience another post-transaction reduction in value. This decline could negatively impact ESOP participants and the other shareholders of the company if they are looking to take a distribution of their account or sell their shares. In order to protect the participants holding the pre-transaction ESOP shares, the ESOP can negotiate a price protection agreement, often referred to as a floor price agreement, which would provide that the company would repurchase the pre-transaction ESOP shares at a minimum guaranteed price. The purpose of the floor price is to protect the participants' accounts, particularly accounts who will be taking a distribution in the near future, from the decline in value from the leveraged transaction. The price can be a fixed price, an adjusted price determined by a formula, or the value determined by the independent appraiser adjusted to remove the effect of the related ESOP debt.

A recent private letter ruling (PLR), PLR 200827008, found that a floor price agreement would not create an additional class of stock for purposes of IRC Section 1361(b)(1)(D) - S corporation defined - In general.

PLR Analysis

Precedential status - IRC Section 6110(k)(3) - Precedential status provides that a private letter ruling cannot be "used or cited as precedent."
Background – The Corporation that requested the PLR originally formed an ESOP as a less than 100% ESOP-owned C Corporation. In a second-stage transaction, the corporation acquired the remaining shares of the company to become 100% ESOP-owned and became an S Corporation.

In order to protect the participants holding the "Pre-Transaction ESOP Shares", the Company entered into a "Floor Price Agreement". The Floor Price Agreement provided that the company would repurchase the Pre-Transaction ESOP shares at a minimum price. The minimum price was the value determined by the independent appraiser without considering the effect of the ESOP debt used to acquire the remaining shares.
One class of stock requirement – IRC Section 1361(b)(1) - S corporation defined - In general defines the term small business corporation (S Corporation) as a domestic corporation which does not have more than one class of stock:

(b) Small business corporation
(1) In general
For purposes of this subchapter, the term "small business corporation" means a domestic corporation which is not an ineligible corporation and which does not—
(A) have more than 100 shareholders,
(B) have as a shareholder a person (other than an estate, a trust described in subsection (c)(2), or an organization described in subsection (c)(6)) who is not an individual,
(C) have a nonresident alien as a shareholder, and
(D) have more than 1 class of stock.
Identical rights to distribution – Treasury Regulations, Subchapter A, Sec. 1.1361-1(l)(1) S corporation defined provides that a corporation is treated as having only one class of stock if all outstanding shares of stock confer identical rights to distribution and liquidation proceeds:

(l) Classes of stock—(1) General rule. A corporation that has more than one class of stock does not qualify as a small business corporation. Except as provided in paragraph (l)(4) of this section (relating to instruments, obligations, or arrangements treated as a second class of stock), a corporation is treated as having only one class of stock if all outstanding shares of stock of the corporation confer identical rights to distribution and liquidation proceeds. Differences in voting rights among shares of stock of a corporation are disregarded in determining whether a corporation has more than one class of stock. Thus, if all shares of stock of an S corporation have identical rights to distribution and liquidation proceeds, the corporation may have voting and nonvoting common stock, a class of stock that may vote only on certain issues, irrevocable proxy agreements, or groups of shares that differ with respect to rights to elect members of the board of directors.
Identical rights to distribution and liquidation – Treasury Regulations, Subchapter A, Sec. 1.1361-1(l)(2)(i) S corporation defined defines how the determination of whether stock confers identical rights to distribution and liquidation proceeds is determined:

(2) Determination of whether stock confers identical rights to distribution and liquidation proceeds—(i) In general. The determination of whether all outstanding shares of stock confer identical rights to distribution and liquidation proceeds is made based on the corporate charter, articles of incorporation, bylaws, applicable state law, and binding agreements relating to distribution and liquidation proceeds (collectively, the governing provisions). A commercial contractual agreement, such as a lease, employment agreement, or loan agreement, is not a binding agreement relating to distribution and liquidation proceeds and thus is not a governing provision unless a principal purpose of the agreement is to circumvent the one class of stock requirement of section 1361(b)(1)(D) and this paragraph (l). Although a corporation is not treated as having more than one class of stock so long as the governing provisions provide for identical distribution and liquidation rights, any distributions (including actual, constructive, or deemed distributions) that differ in timing or amount are to be given appropriate tax effect in accordance with the facts and circumstances
Redemption agreements are disregarded in determining whether shares of stock confer identical rights to distribution – Treasury Regulations, Subchapter A, Sec. 1.1361-1(l)(2)(iii) S corporation defined provides that certain agreements are disregarded in determining whether shares of stock confer identical rights to distribution and liquidation proceeds:

(iii) Buy-sell and redemption agreements—
(A) In general. Buy-sell agreements among shareholders, agreements restricting the transferability of stock, and redemption agreements are disregarded in determining whether a corporation's outstanding shares of stock confer identical distribution and liquidation rights unless—
(1) A principal purpose of the agreement is to circumvent the one class of stock requirement of section 1361(b)(1)(D) and this paragraph (l), and
(2) The agreement establishes a purchase price that, at the time the agreement is entered into, is significantly in excess of or below the fair market value of the stock.
Agreements that provide for the purchase or redemption of stock at book value or at a price between fair market value and book value are not considered to establish a price that is significantly in excess of or below the fair market value of the stock and, thus, are disregarded in determining whether the outstanding shares of stock confer identical rights. For purposes of this paragraph (l)(2)(iii)(A), a good faith determination of fair market value will be respected unless it can be shown that the value was substantially in error and the determination of the value was not performed with reasonable diligence. Although an agreement may be disregarded in determining whether shares of stock confer identical distribution and liquidation rights, payments pursuant to the agreement may have income or transfer tax consequences.
(B) Exception for certain agreements. Bona fide agreements to redeem or purchase stock at the time of death, divorce, disability, or termination of employment are disregarded in determining whether a corporation's shares of stock confer identical rights. In addition, if stock that is substantially nonvested (within the meaning of §1.83–3(b)) is treated as outstanding under these regulations, the forfeiture provisions that cause the stock to be substantially nonvested are disregarded. Furthermore, the Commissioner may provide by Revenue Ruling or other published guidance that other types of bona fide agreements to redeem or purchase stock are disregarded.
(C) Safe harbors for determinations of book value. A determination of book value will be respected if—
(1) The book value is determined in accordance with Generally Accepted Accounting Principles (including permitted optional adjustments); or
(2) The book value is used for any substantial nontax purpose.

Related Links

S ESOPs Create More Revenue for the Treasury, Price Protection PLR

Protecting Intellectual Property

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Sun, 03 Aug 2008 19:55:00 +0000

Managing Intellectual Property provides a checklist of finance, legal, IT, and HR tasks to consider for protecting intellectual property:

FINANCE TASKS
- Inventory all intellectual property
- Prioritize an action plan for correcting deficiencies and reducing risk
- Consider insurance strategies
LEGAL TASKS
- Have basic agreements in place and ensure they're used
IT TASKS
- Have a secure IT network and computer systems
- Have robust data retention policies and procedures
HR TASKS
- Ensure employee handbook and personnel policies provide guidelines for protecting IP
- Establish physical procedures
- Establish systems and additional safeguards
- Ensure the training and education of all employees on all aspects of IP and protection thereof

Congressional ESOP Champions/What Constitutes Good Congressional Support/Historical and Current ESOP Advocates

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Fri, 01 Aug 2008 15:01:00 +0000

Do You Really Know Who Supports Employee Stock Ownership? explores how Rep. Dana Rohrabacher [R-CA] and Rep. Ron Paul [R-TX] have consistently supported ESOPs, and cites H.R. 6419: To amend the Internal Revenue Code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock as a recent example. The post discusses what constitutes good Congressional support:

A nice remark about employee stock ownership, however, is not good enough, as what employee ownership advocates need to protect stock programs such as ESOPs is more than nice words, and a pat on the back. A member of Congress needs to stand up for employee stock ownership, just as Congressman Paul, and Congressman Rohrabacher have done year after year by signing on to pro-ESOP, or pro-employee stock ownership proposals. And on the key committees, a vote for the pro-ESOP position, or a speech in public, before the press and colleagues, also qualifies as a true pro-employee stock ownership position.

It provides a historical look at the Congressional support of ESOPs:

1980-1986: "limited, but very, very deep" support from Russell B. Long and President Ronald Reagan
1986-1989: "ESOPs had to rely on a handful of members to save ESOPs", such as Beryl Anthony, Cass Ballenger, Sen. Max Baucus [D-MT], and Rep. Dana Rohrabacher [R-CA].
1989-2000: "very wide, but shallow" support

It also expresses concern of current ESOP support in the majority party:

In recent years, we are unsure who among the majority party in Congress will really stand up with intensity and push to promote employee stock ownership. We are making progress, but there is not a comfort level that any Democrat in Congress would fight for employee stock ownership.

H.R. 6419: To amend the Internal Revenue Code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Fri, 01 Aug 2008 14:34:00 +0000

Rep. Dana Rohrabacher [R-CA] introduced H.R. 6419: To amend the Internal Revenue Code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock on June 26, 2008, which was cosponsored by Rep. Virgil Goode [R-VA], Rep. Walter Jones [R-NC], and Rep. Peter Roskam [R-IL], and has been referred to the House Ways and Means Committee. Rep. Ron Paul [R-TX] also cosponsored the bill on July 17, 2008.

Here is the text of the legislation:

HR 6419 IH

110th CONGRESS

2d Session

H. R. 6419

To amend the Internal Revenue Code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock.

IN THE HOUSE OF REPRESENTATIVES

June 26, 2008

Mr. ROHRABACHER (for himself, Mr. GOODE, Mr. JONES of North Carolina, and Mr. ROSKAM) introduced the following bill; which was referred to the Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. QUALIFIED STOCK DISTRIBUTIONS TO EMPLOYEES.

(a) In General- Part III of subchapter B of chapter 1 of the Internal Revenue Code of 1986 is amended by inserting after section 139A the following new section:

'SEC. 139B. QUALIFIED STOCK DISTRIBUTIONS TO EMPLOYEES.

'(a) In General- Gross income shall not include--

'(1) so many shares of any stock received by an individual in a qualified employee stock distribution of such individual's employer as does not exceed the maximum stock amount, and

'(2) any gain on stock excluded from gross income under paragraph (1) if such stock is held by such individual for not less than 10 years.

'(b) Definitions and Special Rules- For purposes of this section--

'(1) QUALIFIED EMPLOYEE STOCK DISTRIBUTION- The term 'qualified employee stock distribution' means a distribution by an employer of stock of such employer to all employees (determined as of the date of the distribution) of such employer as compensation for services.

'(2) MAXIMUM STOCK AMOUNT- The term 'maximum stock amount' means, with respect to any distribution, the lowest number of shares of stock of the employer received by any employee of the employer in such distribution.

'(c) Employment Taxes- Amounts excluded from gross income under subsection (a)(1) shall not be taken into account as wages for purposes of chapters 21, 22, 23, 23A, and 24.

'(d) Recapture if Stock Disposed During Required Holding Period- If an amount is excluded from gross income under subsection (a)(1) with respect to any stock and the individual disposes of such stock at any time during the 10-year period beginning on the date that such individual received such stock--

'(1) the gross income of such individual for the taxable year which includes the date of such disposition shall be increased by the amount so excluded, and

'(2) the tax imposed by this chapter for such taxable year shall be increased by the sum of the amounts of tax which would have been imposed under subchapters A and B of chapters 21 and 22 if subsection (c) had not applied with respect to such amount.

For purposes of this title and the Social Security Act, any increase in tax under paragraph (2) shall be treated as imposed under the provision of chapter 21 or 22 with respect to which such increase relates.

'(e) Regulations- The Secretary shall issue such regulations as may be necessary or appropriate to carry out this section, including regulations which provide for the application of this section to stock options.'.

(b) Clerical Amendment- The table of section for such part is amended by inserting after the item relating to section 139A the following new item:

'Sec. 139B. Qualified stock distributions to employees.'.

(c) Effective Date- The amendments made by this section shall apply to stock received by employees after December 31, 2008.

IRC Section 1042 Tax Deferred Sale of Stock to an ESOP and Private Letter Ruling (PLR) 200827018 Involving a Predecessor LLC

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Wed, 30 Jul 2008 17:56:00 +0000

PLR 200827018 is a private letter (PLR) ruling that allowed two selling shareholders of a C Corporation to include the time period that they owned a predecessor LLC that was merged into a newly created C Corporation in the 3-year holding period defined in IRC Section 1042(b)(4) - Sales of stock to employee stock ownership plans or certain cooperatives – Requirements to qualify for nonrecognition – 3-year holding period.

The PLR notes that the merger was part of a IRC Section 368(a)(1)(F) - Definitions relating to corporate reorganizations - Reorganization - In general reorganization ("a mere change in identity, form, or place of organization of one corporation, however effected").

PLR Analysis

Precedential status - IRC Section 6110(k)(3) - Precedential status provides that a private letter ruling cannot be "used or cited as precedent."
Nonrecognition of gain – The shareholders requested a ruling so they can elect to sell their stock to an ESOP under IRC Section 1042(a) - Sales of stock to employee stock ownership plans or certain cooperatives – Nonrecognition of gain and defer long-term capital gains taxation on the sale.

(a) Nonrecognition of gain
If—
(1) the taxpayer or executor elects in such form as the Secretary may prescribe the application of this section with respect to any sale of qualified securities,
(2) the taxpayer purchases qualified replacement property within the replacement period, and
(3) the requirements of subsection (b) are met with respect to such sale, then the gain (if any) on such sale which would be recognized as long-term capital gain shall be recognized only to the extent that the amount realized on such sale exceeds the cost to the taxpayer of such qualified replacement property.
IRC Section 1042 Requirements - IRC Section 1042(b) - Sales of stock to employee stock ownership plans or certain cooperative – Requirements to qualify for nonrecognition defines four requirements to qualify for Section 1042 deferred tax treatment:

(b) Requirements to qualify for nonrecognition

A sale of qualified securities meets the requirements of this subsection if—

(1) Sale to employee organizations

The qualified securities are sold to—

(A) an employee stock ownership plan (as defined in section 4975 (e)(7)), or

(B) an eligible worker-owned cooperative.

(2) Plan must hold 30 percent of stock after sale

The plan or cooperative referred to in paragraph (1) owns (after application of section 318 (a)(4)), immediately after the sale, at least 30 percent of—

(A) each class of outstanding stock of the corporation (other than stock described in section 1504 (a)(4)) which issued the qualified securities, or

(B) the total value of all outstanding stock of the corporation (other than stock described in section 1504 (a)(4)).

(3) Written statement required

(A) In general

The taxpayer files with the Secretary the written statement described in subparagraph (B).

(B) Statement

A statement is described in this subparagraph if it is a verified written statement of—

(i) the employer whose employees are covered by the plan described in paragraph (1), or

(ii) any authorized officer of the cooperative described in paragraph (l), consenting to the application of sections 4978 and 4979A with respect to such employer or cooperative.

(4) 3-year holding period

The taxpayer's holding period with respect to the qualified securities is at least 3 years (determined as of the time of the sale).

Employer securities – IRC Section 409(l) - Qualifications for tax credit employee stock ownership plans - Employer securities defined provides a definition of employer securities:

(l) Employer securities defined

For purposes of this section—

(1) In general

The term "employer securities" means common stock issued by the employer (or by a corporation which is a member of the same controlled group) which is readily tradable on an established securities market.

(2) Special rule where there is no readily tradable common stock

If there is no common stock which meets the requirements of paragraph (1), the term "employer securities" means common stock issued by the employer (or by a corporation which is a member of the same controlled group) having a combination of voting power and dividend rights equal to or in excess of—

(A) that class of common stock of the employer (or of any other such corporation) having the greatest voting power, and

(B) that class of common stock of the employer (or of any other such corporation) having the greatest dividend rights.

(3) Preferred stock may be issued in certain cases

Noncallable preferred stock shall be treated as employer securities if such stock is convertible at any time into stock which meets the requirements of paragraph (1) or (2) (whichever is applicable) and if such conversion is at a conversion price which (as of the date of the acquisition by the tax credit employee stock ownership plan) is reasonable. For purposes of the preceding sentence, under regulations prescribed by the Secretary, preferred stock shall be treated as noncallable if after the call there will be a reasonable opportunity for a conversion which meets the requirements of the preceding sentence.

(4) Application to controlled group of corporations (see Code)

(5) Nonvoting common stock may be acquired in certain cases (see Code)

Qualified securities – IRC Section 1042(c)(1) - Sales of stock to employee stock ownership plans or certain cooperative – Definitions; special rules – Qualified securities defines qualified securities as employer securities that are held by a closely held C corporation company that has not received its stock through certain stock arrangements:

(1) Qualified securities
The term "qualified securities" means employer securities (as defined in section 409(l)) which—
(A) are issued by a domestic C corporation that has no stock outstanding that is readily tradable on an established securities market, and
(B) were not received by the taxpayer in—
(i) a distribution from a plan described in section 401 (a), or
(ii) a transfer pursuant to an option or other right to acquire stock to which section 83, 422, or 423 applied (or to which section 422 or 424 (as in effect on the day before the date of the enactment of the Revenue Reconciliation Act of 1990) applied).

Other provisions – IRC Section 1042 - Sales of stock to employee stock ownership plans or certain cooperatives contains additional requirements, including the IRC Section 1042(a)(2) requirement to purchase qualified replacement property (generally stocks or bonds of domestic companies) within the replacement period (three months before to twelve months after the sale):

(c) Definitions; special rules
(1) Qualified securities
(2) Eligible worker-owned cooperative
(3) Replacement period
(4) Qualified replacement property
(A) In general
(B) Operating corporation
(C) Controlling and controlled corporations treated as 1 corporation
(D) Security defined
(5) Securities sold by underwriter
(6) Time for filing election
(7) Section not to apply to gain of C corporation
(d) Basis of qualified replacement property
(e) Recapture of gain on disposition of qualified replacement property
(1) In general
(2) Special rule for corporations controlled by the taxpayer
(3) Recapture not to apply in certain cases
(f) Statute of limitations
(g) Application of section to sales of stock in agricultural refiners and processors to eligible farm cooperatives
(1) In general
(2) Qualified refiner or processor
(3) Eligible farmers' cooperative
(4) Special rules
Treasury Regulation - Sec. 1.1042-1T Questions and answers relating to the sales of stock to employee stock ownership plans or certain cooperatives (temporary) answers the following questions in a Q&A format:

1. What does section 1042 provide?
2. What is a sale of qualified securities for purposes of section 1042(b)?
3. What is the time and manner for making the election under section 1042(a)?
4. What is the basis of qualified replacement property?
5. What is the statute of limitations for the assessment of a deficiency relating to the gain on the sale of qualified securities?
6. When does section 1042 become effective?

Other Section 1042 Transaction Thoughts

The sellers can avoid taxation upon the death of the seller, as the heirs will receive the property with a stepped-up basis.
Two or more shareholders may combine their sales to meet the 30% requirement.
Certain allocation restrictions apply to the selling shareholder(s) and certain relatives. In most cases, they will be unable to share in the allocation of the ESOP shares, even if they remain employees of the company.
Using ESOP Planning to React to Changing Times notes how an increase in capital gains rates, which could happen in the near future, could create an increase in Section 1042 transactions.
Analysis of IRC Section 401(a)(35) Proposed Regulations – Definition of Publicly Traded and the Impact on Other ESOP Provisions discusses how IRC Section 401(a)(35) Regulations - REG–136701–07 - Diversification Requirements for Certain Defined Contribution Plans could impact thinly traded companies, including the impact on Section 1042.
REITs as Section 1042 Qualified Replacement Property discusses how an argument has been made that certain real estate investment trusts (REITs) may be eligible as qualified replacement property.
ESOPs and Charitable Contributions discusses how an IRC Section 1042 sale can be combined with charitable giving to achieve the seller's estate planning objectives.

Study: S ESOP Companies Create Jobs and Savings for Workers and Have Higher Productivity, Profitability, Job Stability, and Job Growth

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 29 Jul 2008 14:33:00 +0000

Last month we discussed how a recent Study Asserts that Broader Employee Ownership and Participation Improves Company Performance and Social Welfare. New University of Pennsylvania Study Finds S ESOPs Yield Billions in New Benefits for U.S. Workers and the Economy announces that a new study finds that S ESOPs create new jobs and savings that would not have otherwise been earned:

WASHINGTON, July 28 /PRNewswire-USNewswire/ -- In a new University of Pennsylvania study, two leading tax and economic experts found that Subchapter S companies owned by their employees through ESOPs generate some 85,000 new jobs each year and create $14 billion in new savings for workers that otherwise would not have been earned. "From a long-term societal perspective," write the study's authors, "it is perhaps the best possible gain: a forced retirement plan."

The authors reported that S ESOPs offer their workers higher job stability, which accounts for $3 billion worth of the workers' savings. Moreover, they found, S ESOPs' higher productivity, profitability, job stability and job growth collectively help ESOP companies amass $33 billion more in combined earnings than what they would earn if they were not ESOP-owned S corporations.

The authors' economic analysis of the current-law tax benefits for S ESOP companies led them to conclude that the creation of S ESOPs by Congress more than a decade ago has increased tax collections from both employees and employers. This, the authors report, is largely because the additional wealth created by S ESOPs generates additional federal and state taxes; because S ESOPs do not expand capacity among deferred-tax savings options (such as 401k's and others, which they note are under-utilized); and because workers pay taxes on their S ESOP savings accounts when they are liquidated at rates substantially higher than what are paid on other tax-deferred plans.

The study, which represents the first ever assessment of the costs and benefits of S corporation ESOP laws, was released yesterday by the University of Pennsylvania's Michael Knoll and Steven Freeman. Freeman is a Senior Lecturer and Resident Scholar in the School of Arts and Sciences and Resident Scholar in the School's Center for Organizational Dynamics. Knoll is the Theodore Warner Professor of Law and holds a secondary appointment at the Wharton School.

S corporation ESOPs have become the subject of some scrutiny, noted Knoll and Freeman, since the December 2007 announcement by Chicago financier Sam Zell that he was acquiring the iconic Tribune Company and converting it to an S-ESOP company. According to the authors, Congressional passage of laws allowing for S ESOPs more than a decade ago has led to the creation of nearly 3,700 S ESOP companies nationwide (about 40 percent of all U.S. ESOPs), and that about 3.7 million Americans work and participate in S ESOPs.

Open Book Management: Helping to Eliminate the Emotional and Subjective Conversations

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Tue, 29 Jul 2008 06:00:00 +0000

Open The Books - The Minds Will Open is a blog post that discusses the benefits of open-book management:

Smart companies have recognized that using open book management helps eliminate the emotional and subjective conversations. Open book management is based on the numbers - the facts (unless the organization is so corrupt it cooks its books). Business is about numbers - sales, expenses, inventory, profits, cash, stock value and more.

The fundamental purpose of a company is to offer a service that makes money. If your employees do not understand how their every day actions contribute to the bottom line, I will venture to say that you have a lot of unresolved issues in your company that drive you nuts.

In the News: Acquiring Companies as Part of a Growth and Expansion Model

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Mon, 28 Jul 2008 06:00:00 +0000

Houchens Industries (Bowling Green, KY)

Houchens completes deal for Tampico Beverages discusses how Houchens Industries, the tenth-ranked ESOP on The Employee Ownership 100, acquired Tampico Beverages Inc. as part of its growth and expansion model.

Houchens Industries Inc. on Friday completed its acquisition of Tampico Beverages Inc., part of an aggressive expansion that has included adding a brokerage firm and an optical chain to the employee-owned company..."Our strategy is to diversify our holdings so we don't have too many eggs in one basket, and to buy very profitable companies that have growth potential and have good management," Coates said in an interview.

Houchens said Tampico Beverage will retain its name, employees and management team based in Chicago. It was the latest acquisition by a company that has accelerated its buyout activity since clearing about $1.5 billion from the sale of its Commonwealth Brands cigarette subsidiary to the British company Imperial Tobacco Group PLC in a $1.9 billion deal in 2007…Already this year, Houchens has closed deals to acquire brokerage and financial services firm Hilliard Lyons and the Cohen's Fashion Optical chain. It also acquired regional grocery store chain Buehler Foods and acquired 50 percent interest in a Kentucky-based fence materials distribution company.

The article also discusses how the company is continuing to look for more companies and discusses the company's current holdings and sales:

Houchens' holdings also include convenience stores, restaurants, insurance, construction, manufacturing, recycling, tanning supply distribution and software and Website development. With its latest additions, Houchens' overall yearly sales will reach about $3 billion, Coates said.

Here are some additional related ESOP acquisition posts:

10 Reasons to Sell a Company to the Employees and 2 Employee Ownership Analogies

ajuckett@esopinsourcing.com (Employee Stock Ownership Plan (ESOP) Consultant) — Sat, 26 Jul 2008 15:41:00 +0000

Sharing the Reins: 10 Reasons To Sell Your Company To Your Employees contains an article by John Abrams, the former owner of South Mountain Co., that discusses 10 reasons to consider selling a company to the employees:

1. Maturity. Once the entrepreneurial leap of starting a new business has been achieved without constraints, and a viable company has been established, restructuring to employee ownership can be a natural part of the maturation process.

2. Commitment. Employee ownership encourages a sense of empowerment and promises deeper connections and greater commitment (and length of employment) among the employee owners.

3. Freedom. The potential loss of control for the founder is more than balanced by the new-found freedom that comes with shared responsibility.

4. Participation. If you keep the entry fee low enough (we keep ours to "the price of a good used car") full participation will be encouraged.

5. Equity. By using a system of internal capital accounts through which the profit is shared and equity is measured, employee owners can track their stake in the company and accumulate a nest egg that they take with them when they depart.

6. Effectiveness. Over 11,000 companies nationally, with 8.5 million employees (and $400 billion in assets held by these employees) have some form of employee ownership. Maybe these companies know something.

7. Legacy. Employee ownership is the ticket to good legacy and smooth transitions. By sharing ownership early on, the difficult question that comes when founders are ready to retire - what to do with this business - is avoided.

8. Justice. The inherent injustice of our current economic system (all wealth goes to the shareholders) can be tackled, through employee ownership, by shifting wealth to the real stakeholders, those who actually create it.

9. Productivity. A democratic workplace gives meaning to our work lives and encourages good performance. A happy workforce is a productive one.

10. Accountability. If the people who make the decisions are the people who will also bear the consequences of those decisions, better decisions are likely to result.

The article also shares two employee ownership analogies. First, he uses the popular car analogy: "In the history of mankind, nobody has ever washed a rented car." He also compared the dynamics of employee ownership to how the Roman army rationed food:

Rations were in the form of large loaves of bread, each sufficient to feed two soldiers. This presented a problem, since when the soldiers had little to do, they tended to fight among themselves, particularly over who got the bigger half of the loaf. The Romans developed a nifty solution. They passed a regulation that one soldier had to divide the loaf and the other chose which half to take. Employee ownership is a similarly self-enforcing system. Each owner's actions on behalf of the others, and the company, are actions on his or her own behalf at the same time.

We also discussed the South Mountain Co. in In the News: More Responsibility and Better Decision-Making and In the News: Employee Ownership Success Stories.