I.
What is an ESOP?
An Employee Stock Ownership Plan ("ESOP") is a "qualified
employee retirement plan that is designed to invest primarily
in stock of the sponsoring company. The federal income tax
laws promote the use of ESOPs both as an employee benefit
and as a technique of corporate finance. Because an ESOP is
a "qualified" plan, it must satisfy the discrimination, participation,
vesting, distribution and other requirements of the Internal
Revenue Code of 1986 ("IRC") and the Employee Retirement Income
Security Act of 1974 ("ERISA").
An ESOP is a "defined contribution" plan. It consists of either
(i) a stock bonus plan, or (ii) a combination stock bonus
and money purchase pension plan. An ESOP must be designed
to invest primarily in "employer securities". Basically, an
"employer security" is common stock of the sponsoring company
that (i) is readily tradeable on an established U.S. securities
market, or (ii) is not readily tradeable, but has a combination
of voting power and dividend rights at least equal to any
other securities of the sponsoring company.
An ESOP has two components: (i) the plan document itself,
which sets forth in writing the terms of the ESOP, and (ii)
the trust agreement, which sets forth in writing the powers,
duties and other rights and responsibilities of the trustee
of the ESOP participants. Corporate officers of the sponsoring
company often serve as the trustees. The sponsoring company
may, however, appoint a corporate trustee.
A. Leveraged ESOPs
A leveraged ESOP borrows funds to purchase employer securities.
The loan to the ESOP can be made by the sponsoring company,
or it can be made by a bank or financial institution and
guaranteed by the company. The stock purchased with the
loan proceeds is held in trust by the ESOP trustee in a
separate "suspense" account, as collateral for the loans.
As the loan is repaid, the trustee allocates stock from
the suspense account to separate accounts established for
each employee participating in the ESOP. The amounts allocated
to each participant's account remain in trust. Subject to
the ESOP's vesting schedule, the amount allocated to each
participant's termination of employment, death, disability
or retirement.
The employer makes contributions to the leveraged ESOP that
are then used to repay the principal of the ESOP loan. These
contributions are deductible to the employer in an amount
up to 25% of the aggregate compensation of all ESOP participants.
Contributions used to pay interest on the loan are fully
deductible to the employer, provided certain allocation
tests are met. Loans to the ESOP by the employer or loans
guaranteed by the employer are exempted under the IRC and
ERISA from being "prohibited transaction".
B.
The ESOP As An Employee Benefit Plan
ESOPs, like all tax-qualified retirement plans, must
meet certain minimum requirements set forth in the IRC.
The ESOP must provide a trust which will hold all of the
assets of the plan. The ESOP must operate for the exclusive
benefit of participants and their beneficiaries. The sponsor
must intend the plan as a permanent plan (although it may
terminate the plan at any time for a valid business reason)
and it must intend to have the trust's assets and income
distributed to the plan participants and their beneficiaries.
The plan must cover at least 50 employees or 40% of the
company's employees, whatever is less. Also, a plan must
comply with specific "coverage" and "non-discrimination"
rules designed to assure that the plan does not operate
in a manner which favors officers and other highly compensating
employees.
ESOP assets (cash and employer stock) acquired during each
year (including any employer securities released from a
suspense account) are allocated at year end to individual
bookkeeping accounts established by the trustee for each
employee participating in the ESOP participants. These accounts
are part of the ESOP trust and are administered by the trustee,
who is responsible for protecting the interests of employees
and their beneficiaries.
An employee's ownership interest in his account in the ESOP
trust is called his "vested interest", and the formula which
determines his vested interest is set out in the ESOP's
"vesting schedule". An ESOP, like most employee benefit
plans, is designed to benefit employees who remain with
the company the longest and contribute the most to the employer's
success. Therefore, an employee's vested interest in the
cash and employer securities held in his account in the
ESOP trust is usually based on his number of years of employment.
The minimum vesting standards which an ESOP must generally
provide are either:
(i) 100% vesting after five years of service;
or
(ii) a vesting schedule no less favorable than:
|
Years of Service
|
|
Percentage
Vested
|
Less than 3
|
|
0%
|
3
|
|
20%
|
4
|
|
40%
|
5
|
|
60%
|
6
|
|
80%
|
|
7 or more |
|
100% |
If an employee terminates employment for any
reason other than retirement, death or disability, his vested
interest under the ESOP is determined by referring to the
ESOP's vesting schedule. If the employee has not worked
long enough to have a vested interest in all of the stock
and cash in his account, he forfeits the cash and employer
securities in which he does not have a vested interest.
The cash and stock that is forfeited is allocated among
the accounts of the remaining ESOP participants in the same
way that employer contributions are allocated.
If an employee retires or, in most cases, if he dies or
is disabled, he will be 100% vested in all of the cash and
employer securities in his account. Each employee who participates
in the ESOP may designate a beneficiary who will be entitled
to the participant's vested interest on the participant's
death. A participant may receive his ESOP benefit in a lump
sum distribution during a single taxable year or in several
annual installments.
The ESOP must begin to distribute vested benefits to a participant
who has terminated his employment no later that the later
of (i) the sixth year after the participant's termination,
unless the participant consents to deferral to a later date,
or (ii) the repayment in full of any loan used by the ESOP
to finance its purchase of the employer securities.
An ESOP may make distributions either in cash or in employer
securities, provided that each participant must have the
right to demand that his benefits be distributed in shares
of employer securities. However, if the sponsoring employer's
corporate charter or by-laws restrict ownership of "substantially
all" outstanding employer securities to employees or to
a qualified trust, cash distributions may be made without
granting participants the right to demand stock.
Participants receiving employer securities of a private
company as a distribution have a right to "put" those securities
to the employer during certain specified time periods.
|
