Employee Stock Ownership Plans

The ESOP practice assists corporations in analyzing whether an ESOP is appropriate for their particular situation. We assist the client with an analysis of the ESOP's financial impact; design and draft the ESOP if it is appropriate; obtain a favorable determination letter from the IRS regarding the ESOP's tax status; and assist the client in preparing a communications program to explain the ESOP to its employees.

 

The ESOP in this context may be designed to fund a corporation's match under a Section 401(k) plan, to buy out a particular shareholder, to be part of a management buyout, or just to increase the equity interest of the employees in the corporation.

Section 1042 of the Internal Revenue Code (IRC) provides that a shareholder of a private company who sells his or her stock to an ESOP may defer, and in some cases completely avoid, income tax on the proceeds received from such sale if certain requirements are satisfied. These requirements include the reinvestment of the proceeds in qualifying reinvestment property within a specified period.

The ESOP practice has designed Section 1042 ESOP transactions having a value of over $2.5 billion. Our involvement includes restructuring the corporation so as to allow the shareholders to avail themselves of the Section 1042 deferral, the designing of specialized securities to be acquired by the ESOP, the implementing and negotiating of the ESOP acquisition, and assuring that the ERISA fiduciary requirements related to the ESOP are satisfied.

The ESOP practice also assists selling shareholders with the reinvestment of ESOP sale proceeds in qualifying reinvestment property to insure the availability of the Section 1042 deferral. We also advise selling shareholders with respect to monetization techniques available to allow the selling shareholder to realize cash from the qualified reinvestment property without jeopardizing the favorable tax treatment.

As part of this process, we coordinate with the selling shareholders’ estate planner to insure that the unique estate planning opportunities available to Section 1042 reinvestment property are maximized.

The ESOP practice represents clients who are acquiring or investing in a corporation that is partially or completely owned by an ESOP.

Our work in this area includes:

• Due diligence to identify unique liabilities that are associated with the existence and initial establishment of the ESOP; 
• Insuring that the ESOP fiduciary rules are complied with in connection with the acquisition or investment transaction;
• Negotiating the acquisition of the stock from the ESOP; and
• Overseeing the termination of the ESOP and the distribution of the ESOP assets to participants.

An S-Corporation may establish and maintain an ESOP. Stated simply, an S-Corporation is a corporation that has elected to be taxed as a partnership. The main economic advantage of an S-Corporation is the elimination of double taxation to the S-Corporation's stockholders. The S-Corporation does not pay corporate income at the corporate level; rather, the shareholders pay tax on their proportionate share of the S-Corporation's income. Since an ESOP is a tax-exempt entity, its share of the income is not subject to federal income tax. Each state must be reviewed separately to determine whether it recognizes pass-through entities such as S-Corporations.

The advantage S-Corporation status provides to an ESOP is very unique and can be best illustrated by an example: If an ESOP owns 100 percent of a company with $100 million in annual net income, there will be no federal income tax paid on the $100 million in annual net income and the company will have $100 million remaining after tax. By contrast, a similarly situated C-Corporation with $100 million in annual net income will pay approximately $35 million in taxes and will have only $65 million remaining after payment of taxes. This tax advantage obviously can provide an ESOP-owned company with a real cost advantage over competitors. The company could use the $35 million in tax savings to pay down debt, reinvest in the company, or make distributions to the shareholder. A company does not have to be 100 percent owned by an ESOP to take advantage of this tax treatment, but the 100 percent ownership example best illustrates the tax advantage.

The ESOP practice has extensive experience in analyzing whether an S-Election is appropriate for a particular ESOP-owned corporation and in restructuring a corporation to enable it to take advantage of the S-Election.

ESOPs are an attractive exit strategy for private equity firms looking to sell a portfolio company. The unique tax aspects of ESOPs, such as S-Corporation status, create a transaction that may be more easily financed than a traditional transaction. Moreover, the motivational aspect of an ESOP is ideally suited to a company that is desirous of becoming a free-standing independent company.

In certain circumstances it may also be possible for the selling private equity firm to avail itself of the tax advantages of a Section 1042 sale to an ESOP.

The ESOP practice represents major corporate fiduciaries and individual fiduciaries across the country in all types of ESOP transactions.

Our representation includes representing fiduciaries in connection with the purchase and sale of employer securities by ESOPs, in going-private transactions, in restructuring of troubled corporations owned by ESOPs, in obtaining new ESOP loans, and in the refinancing of existing ESOP loans and innumerable other transactions that require the ESOP fiduciary to exercise its discretionary fiduciary judgment.

The ESOP practice has developed particular experience in representing fiduciaries of large, troubled public companies and advising such fiduciaries with respect to when the fiduciary is required by the ESOP plan document or ERISA to sell the company stock owned by the ESOP.

Our work in this area includes:

• Advising the fiduciary regarding its fiduciary duties under ERISA;
• Insuring compliance with Department of Labor guidelines regarding fiduciary process;
• Performing due diligence with respect to the proposed transaction;
• Assisting the fiduciary in evaluating the proposed transaction;
• Assisting the fiduciary in the negotiating of the terms of the transaction; and
• Preparing and reviewing of transaction documents.

We represent banks and other lenders involved in making loans to facilitate ESOP transactions. Our services include customizing loan documents to include ESOP-specific provisions.

We represent corporations and fiduciaries in connection with IRS and DOL investigations of ESOPs and ESOP transactions. Our representation includes responding to IRS and DOL subpoenas, preparing clients for agency interviews, depositions, and defending clients in disputes with the IRS and DOL.

We have also been involved in a wide variety of litigation involving fiduciaries and ESOPs.