Now that we are mid-way through 2012, I thought it would be a good time to write a series of blogs on ESOP Distributions, as most calendar year plans are in, or will soon be in, their ESOP distribution processing season.

We have been discussing some of the many benefits of Selling to an ESOP including how Selling to an ESOP Creates a Built-In Buyer and how Selling to an ESOP in 2012 Increases After-Tax Proceeds by 43%.  In addition to the Higher After-Tax Return, selling to an ESOP can provide additional ways to add capture additional consideration and benefits for the selling shareholder above and beyond the sale proceeds.

We have followed Iowa's Employee Stock Ownership Plan (ESOP) Initiative as it has progressed throughout the legislative process.  Iowa Governor Terry Branstad, who started the process by including Selling to an ESOP as one of his 2012 initiatives in his 2012 Condition of the State address, signed the ESOP provision of House File 2465 into law on May 25, 2012.  The legislation provides a 50% exclusion of the Iowa net capital gains tax from the sale of an Iowa corporation to an ESOP if the ESOP owns at least 30% of the company after the sale.  Here is the final language: 

The ESOP Diversification rules provide that an ESOP must allow qualified participants to diversify a portion of the employer securities held in their account. A “qualified participant” is a participant who has completed at least 10 years of participation in the plan and has attained age 55.

Small business owners continually strive to find better ways to retain and reward employees. Much can be invested over time to help create an environment of happy employees, willing to invest their best efforts each day they come to work.  Yet many business owners struggle to find just the right formula to inspire their people to share in their vision for success.

Fidelity bonding requirements were established with The Employee Retirement Income Security Act of 1974 (ERISA) “to protect employee benefit plans from risk of loss due to fraud or dishonesty on the part of persons who “handle” plan funds or other property.”  The U.S. Department of Labor (DOL) released Field Assistance Bulletin No. 2008-04 on November 25, 2008 to provide guidance on the plan bonding requirements.  Since ESOPs are subject to ERISA, they must comply with the fidelity bonding requirements as well.   

One of the more compelling reasons to Sell to an ESOP is Selling to an ESOP Increases Company Cash Flow by Eliminating Income Taxes.  In other words, the tax savings for Selling to an ESOP will provide the funding for most of the sale of the company to the ESOP.  

On March 30, 2012, the IRS conducted an IRS Nationwide Tax Forum and provided an update on the IRS ESOP Determination Letter Backlog for the 5-Year Remedial Amendment Cycle and for IRS Form 5310 plan terminations.  They stated that they have completed Cycle C ESOP submissions and just started to go into Cycle D submissions.  However, according to Check the Status of Your Determination Letter, no Cycle D cases have been assigned.

Since an ESOP is a qualified defined contribution plan, it needs to follow the vesting rules described in IRC Section 411(a)(2)(B), which provides a plan must use a schedule at least as beneficial as the 3-year cliff vesting schedule or the 6-year graded vesting schedule for employer discretionary contributions.