Deborah Groban Olson
Attorney at Law
______________________________________________________________________________________________
1021 Nottingham Road
Grosse Pointe Park, Michigan 48230
Phone (313) 331 7821
Fax (313) 331 2567
Email dgo@esoplaw.com
Employee
Ownership Law Update
by
January 11, 2001
Retirement Security and Savings Act of 2000 – On September 7, 2000 the Senate Finance Committee approved, by a vote of 19 to 0, a package of ERISA proposals including pro-ESOP proposals very similar to those passed by the House in July (below).
Comprehensive Retirement Security and Pension Reform Act of 2000 – H.R.4843 was passed by the House on July 19, 2000 with a vote of over 400 in favor and 25 opposed. Among other things, it includes these pro-ESOP provisions. It:
· allows ESOP dividends to be deducted by the Company even if they are reinvested by the employee;
· incorporates the Breaux proposals to prevent abusive use of S Corp. ESOPs, without eliminating their benefit for most companies;
· eliminates the 25% of pay contribution limit for defined contribution plans under IRC Sec. 415; increases the annual addition dollar limits from $30,000 per year to $40,000 per year in $1,000 increments; and increases the company contribution limit from 15% for a single plan to 25% under IRC Sec. 404;
· change the top-heavy rules;
· increases the maximum compensation limit for contributions from $170,000 to $200,000;
· raises the annual permissible 401(k) contribution limit in $1,000 increments from $10,000 per year to $15,000 per year, and would not count elective deferrals in this limit.
· “Disqualified persons” are those who:
1) collectively own 50% or more of the company, and
2) either; (a) individually own 10% or more of the company or (b) along with siblings, ascendants and descendants own more than 20% of the company.
· For the purposes of these ownership calculations, shares owned in the ESOP plus a pro-rata share of unallocated ESOP stock is calculated along with any stock owned outside the ESOP as “deemed owned shares”.
· “Synthetic equity”, such as stock options or other claims that can be translated into equity, count as “deemed owned shares”.
· Penalties accrue in any year in which an ESOP allocation is provided to disqualified persons – the company pays a 50% excise tax and the allocations are taxable to the disqualified persons. In the first year, these penalties are owed on all the “deemed owned shares” not just those in the ESOP.
Estate Tax Repeal
passed by the House on June 9, 2000. If signed, such legislation would change a
major impetus for ESOPs. President Clinton vetoed it. However, it is likely that whoever the next President is, there
may be decreases in the estate tax.
The President signed the Worker Economic Opportunity Act (S.2323, H.R. 4182) which exempts stock options from the overtime pay requirements of the Fair Labor Standards Act, provided they meet certain criteria. The stock options or stock appreciation rights must: 1) be granted at not less than 85% of fair market value; 2) be held at least 6 months after grant (except for death, disability and other special circumstances); and 3) plan participation must be voluntary. This legislation arose in response to a DOL opinion to the contrary.
Super-Options Bill - H.R. 3462, the Wealth Through the Workplace Act of 1999 was approved by the House Committee on Education and the Workforce on June 21. It creates a new type of stock option with immediate tax benefits to employers and capital gains treatment for employees. If employees held the stock for 2 years after grant and one year after exercise they would be taxed at capital gains rates on the increase in value. However, the company could take a tax deduction for the spread when the option was exercised. However, this treatment would only be available for options provided to at least 70% of the workforce and a seniority requirement of no more than one year. This benefit would not be available for the company’s most highly compensated employees.
The House Ways and Means Committee had a recent hearing on this. Action is expected in the next session of Congress.
Some interesting cases and
regulatory actions
IRS extended the deadline for amending plans for GUST to the last day of the Plan Year that begins on or after January 1, 2001.
Although plans are obligated to be operated in accordance with these laws, they need not be amended, until the above new remedial amendment date, for changes under the Uruguay Round Agreements Act, the Uniformed Services Employment and Reemployment Rights Act of 1994, the Small Business Job Protection Act of 1996, the Taxpayer Relief Act of 1997 and the IRS Restructuring Act of 1998 (collectively referred to as “GUST”) according to Rev.Proc.2000-27.
In Harris Trust Savings Bank v. Solomon Smith Barney Inc. (27 BPR 14339, 6/13/00) the Court held that if an advisor is a “knowing participant in a fiduciary breach” then that party can be liable for the “act or practice” that broke the law. This contrasts to the shield provided to non-fiduciaries by the 1993 Supreme Court decision in the Mertens v. Hewitt Associates (20 BPR 1235) case. Thus, knowledge of such a breach, not just active participation, may be a source of liability.
IRS disallows company going from S to C back to S corporation after
taking Sec. 1042 election.
In PLR 199952072 the IRS denied a company’s request to reelect S status after it had been an S corporation, became a C corporation five days before a sale of 50% of employer stock to an ESOP. That change enabled use of IRC Sec. 1042. The Company then wanted to reelect S status. The IRS denied the request. Under IRC Sec. 1362(g) there is a five year waiting period for S companies who elect C status to return to S status unless IRS approval is obtained. Here the IRS refused.
An S Corp. ESOP may repay principal or interest on debt with earnings
distributions on unallocated stock in the ESOP and the shares released and
allocated are not “annual additions” under Sec. 415 because they are earnings.
PLR 200014043
Holding of stock in an S corporation, prior to choosing C corporation
status, counts towards the required holding period to qualify securities for
Sec. 1042 treatment.
PLR 20003014
Criminal conviction of company president and his attorneys for stealing
plan assets and covering it up by creating a backdated ESOP.
In US v. Helbing (March 14, 2000) the 3rd Circuit upheld criminal convictions of a company president who embezzled funds from a profit sharing plan, and then attempted to cover it up by later converting the profit sharing plan into an ESOP, selling company stock to the ESOP for the plan’s cash, and backdating the ESOP plan, trust and stock purchase documents to show the ESOP’s creation and the sale occurring prior to the date the cash was removed from the Plan.
An employer can deduct dividends paid on its ESOP stock under Sec. 404(k) when paid directly to participants, or if the dividends are used by the participant to reinvest in other investments within the Plan. Also, if the participant defers wages, in an amount equal to dividends paid out to him, the deferral is not taxable wages. PLR 200033047
Amounts received by an ESOP due to Plan termination, and allocated to participants’ accounts, were determined not to be employer contributions, and thus were “earnings” and not “annual additions” under IRC Sec. 415(c)(2). PLR 200034039. There have been a number of earlier contradictory rulings; so much care is required in this area.
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* Atty. Deborah Groban Olson, has over 19 years experience specializing in employee ownership and equity compensation programs including ESOPs, stock options, and corporate transactions, for companies, individuals selling stock to employees, trustees, and employees, serving as corporate or ESOP counsel. She serves as Board Chair of the National Center for Employee Ownership (NCEO), and chairs the Capital Ownership Group.