The contents of this newsletter constitute only summaries of law. They should not be relied upon as conclusive legal advice, which can be secured only through consultation with a qualified attorney reviewing a concrete factual situation. This is especially true because in addition to being mere summaries, various of the provisions noted herein take effect on different dates. @ 1998 Attorney Deborah Groban Olson c:\mspub/diknew8.htm
Many thoughtful people from diverse classes, races and political views find that Congress has not focused on a key problem of our time, namely; how to organize society to protect people and their local communities as the gap between rich and poor increases, while corporations cease to be governable by national governments. There have been few, practical efforts to bridge the gap between those with constructive ideas on the right and the left. Employee ownership, and broadened capital ownership in general, is one of the few ideas which appeals to many groups across the political spectrum. In March 1997 I first expressed my view that the employee ownership movement should take a leadership role on this issue at the Worker Ownership Institute. In April, I was elected NCEO Chair after informing the Board that I wished to lead NCEO to action on this issue. Thereafter, NCEO members formed a committee called the Capital Ownership Group (COG), based upon our experience that employee ownership fosters broadened participation in the growth and success of companies for employees and local communities. COG is devising a strategy to use broadened capital ownership to increase employee and community share in prosperity and respond to problems created by globalization of the economy. COG's mission is to change the social and economic structure of the economy from one primarily controlled by huge multi-national corporations to one owned and democratically controlled by workers and local families, in which prosperity is shared more broadly.
COG has a three pronged strategy to accomplish this goal 1. Education and discussion within the employee ownership community directed towards building a consensus to move employee ownership from its current use as a tactic, to a more profound use as part of a strategy of social change driven by broadened ownership; 2. Organization of a coalition including employee owned companies, companies embracing the ethics of participation and shared prosperity, community based organizations, labor, governments, established and alternative financial institutions, and religious organizations, to help develop a viable strategy for reaching the agreed upon goals; 3. Development and dissemination of legislative and regulatory policy initiatives to enable these goals. COG's members include people with solid credentials across the political spectrum, in the U.S. and may other countries. Within the employee ownership community these people have collegial relationships and common values concerning broadened ownership. COG members include: Dan Bell, David Binns, Ed Carberry, Bill Carris, Carla Dickstein, Bruce Householder, Jeff Gates, David Johanson, Jalmer Johnson, Mary Joseph, Jim Keogh, Norm Kurland, Mary Landry, John Logue, Dennis Long, Stan Lundine, Ron Ludwig, Chris Mackin, Julia Markus, Andrew Martin, Deb Olson, Marc Mortier, Corey Rosen, Loren Rodgers, June Sekara, Sid Scott, Bob Shinners, Bob Smiley, David Sptizley, Jim Steiker, Jim Tussler, Cindy Van Auken, Ryan Weeden, and Lynn Williams. COG is currently researching viable legislative proposals and organizing to develop a broad political consensus around agreed upon proposals and practical measures to advance broadened ownership. COG's research committee (comprised of academics and practitioners) is surveying the available literature on broadened capital ownership proposals, and related academic research, while our legislative and regulatory committee is compiling all the existing legislative proposals on broadened ownership. In addition, COG is undertaking a research project on the relationship between workplace democracy and employee ownership at the request of Nancy Mills, of the AFL-CIO Office of Workplace Democracy. COG seeks partnerships with other national and community based organizations. COG met in Chicago in October, formed working groups, drafted a mission statement, and learned about various broadened ownership mechanisms. COG will provide a session on broadened ownership at the NCEO April 1998 Minneapolis annual meeting. A COG meeting will follow on Friday afternoon and Saturday morning, to further develop the ideas, strategies and goals discussed above. Please join us. At the leadership assembly of employee ownership organizations last July, all present offered to assist NCEO in the creation and development of COG, including the ESOP Association, the Worker Ownership Institute, the Foundation for Enterprise Development, the ESOP Association Foundation, the Center for Economic and Social Justice, the state employee ownership organizations from Ohio and Massachusetts and the Employee Share Ownership and Investment Association of Canada. In the Spring of 1998 Jeff Gates book, The Ownership Solution, will be published. It includes many concrete legislative and policy ideas for broadening ownership. Those who make a $250 contribution to COG can obtain a pre-publication copy of Jeff's book. For a wider view of the globalization problem, I recommend Bill Greider's 1997 book, One World Ready or Not, the Manic Logic of Global Capitalism. In Chapter 18 he shows how employee ownership can provide a part of the solution. Upcoming COG Events - April 24 - 25, 1998 in Minneapolis To join COG or get more information, please call or Email Ryan Weeden at NCEO (510) 208-1801 or rweeden@nceo.org. or contact Deborah Olson (313) 331-7821 or DebGrobanOlson @compuserve.com. COG Receives Initial Financial Support
The Ohio Employee Ownership Center (OEOC) at Kent State University (KSU) has contracted with Atty. Deborah Olson to seek grant funding for the Captial Ownership Group (COG), described elsewhere herein, the Ohio portion of the Heartland Investment Fund, and other related projects. Additionally, the NCEO has provided $3,000 for administrative support to COG, which has been matched by a number of individuals responding to a challenge grant from Bob Smiley and to Jeff Gates kind offer to provide pre-publication copies of his manuscript of The Ownership Solution to anyone contributing at least $250 to COG. That offer still stands and is being handled by NCEO (510) 272- 9461.
The 1996 tax law enabled Sub-Chapter S corporations to create ESOPs and Stock Bonus Plans. For taxable years beginning after December 31, 1997 a Sub-Chapter S corporation may have a tax exempt trust, such as an ESOP, as a stockholder. The trust counts as one of the 75 permitted shareholders. The Sub S ESOP is not eligible for many of the tax benefits available to a Sub-Chapter C corporation. (S corporation shareholders in company's with ESOPs will not be eligible for the tax free rollover under IRC §1042 on sales of their stock to an ESOP. The S corporation ESOP cannot deduct dividends paid to employees, and will have to count interest on a loan when calculating the contribution amount for annual limitations on contributions. The contribution limit for an S corporation ESOP is 15% of covered compensation.)
Under the Taxpayers Relief Act of 1997 (TRA 97), unlike other types of qualified plans now permitted in S companies as of SBJPA of 1996, only the ESOP is exempt from payment of unrelated business income tax (UBIT), while profit sharing plans, stock bonus plans and 401(k) plans must pay UBIT. A Sub-Chapter S company sponsoring an ESOP may distribute a participant's account in cash, not stock. Thus, a Sub-S company need not be concerned that it may be dissolved upon distribution to ESOP participants. A Sub-Chapter S company sponsoring an ESOP has exemptions from ERISA and IRS prohibited transaction rules similar to those for a C corporation sponsoring an ESOP. Taxable income of a Sub-Chapter S company sponsoring an ESOP, pro rated to the ESOPs share of ownership will not be subject to federal income tax, except when distributed to participants of the ESOP. Unrelated business income tax (UBIT) shall not be applied to the ESOP. This UBIT exemption applies only to ESOPs and not to profit sharing, stock bonus or 401(k) plans. Thus, ESOP participants have a tax benefit arguably better than other Sub S shareholders due to the deferral aspect of qualified plans. While the individual S shareholder owes taxes annually on the S company's earnings, the ESOP participant owes no taxes on the earnings of his S company stock until he receives his ultimate taxable distribution from the ESOP. Thus, where the C corporation is profitable and has a substantial tax burden, and a seller is eligible to take a § 1042 rollover, the seller might consider the following. The individual owner(s) sell their entire interest in the company in a § 1042 transaction, allowing the selling owners the full benefit of §1042. Thereafter the company could elect Sub-Chapter S status. If it were then 100% owned by the ESOP, it would not pay income taxes on any income. Each participant would owe income taxes upon termination of employment and receipt of his/her ESOP distribution. There are a number of issues to consider before converting from a C corporation to an S, including these: 1) on conversion an S corporation using LIFO is subject to a LIFO recapture tax; 2) for a 10 year period after the conversion, if the company sells any assets it held on the day of its S election, it will have to pay "built in gains tax" on that sale, in addition to the taxes paid by the shareholders; 3) in S corporations some fringe benefits paid to 2% or more owners are taxable; 4) net operating losses incurred as a C corp. are suspended while an S corp. (These losses may be applied against LIFO or built-in gains taxes, however.); 5) S corporations must operate on a calendar year; 6) all shareholders must consent to the election; 7) and an S corporation can have only one class of stock and only 75 shareholders..
If the employee deferral part of a 401(k) plan is 10% or more invested in company stock, the company cannot require that its employees' contributions be invested in company stock. ESOP/401(k) plans are specifically excluded from this TRA 97 rule and may require employees to invest their deferrals in company stock. However, few companies make such a requirement and most advisors find it is not a wise policy. TRA 97 created these additional employee ownership incentives
With the top capital gains rates roughly half of the top ordinary income tax rate, corporations are likely to become more interested in deferred compensation plans. The biggest impact will be on qualified Incentive Stock Option (ISO) plans. ISO's are issued at their then current fair market price. They benefit the holder or his estate from growth in stock value. Whereas, with a non-qualified stock option the estate would have to pay taxes on the incremental value of the exercised stock option. The former 15% tax on excess contributions and excess accumulations led many companies to create non-qualified plans. With its repeal, many companies may become more interested in qualified stock option plans again. Additionally, Rep. Houghton of the House Ways and Means Committee has introduced a bill (HR 2788) to increase the permitted annual amount of stock options for a highly compensated employee from $100,000 to $200,000 where half or more of the stock options go to non-highly compensated employees.
Under TRA 97, up to $1.3 million of stock in a family owned business interest can be transferred to a family member exempt from estate or gift tax as part of the unified credit. Heirs who receive family-owned business interest stock, but are not interested in running the business, can use the §1042 tax free rollover to liquidate their family owned business interest stock and defer the payment of capital gains tax on it, while keeping the business locally owned.
When an employee's participation in a plan terminates, if the account balance does not exceed $5,000, the plan may pay out the account balance to the participant without his or his spouse's consent. Previously such payments were limited to accounts no greater than $3,500.
Summary Plan Descriptions (SPDs) and Summaries of Material Modification (SMM's) need no longer be filed with the Department of Labor effective as of August 5, 1997. However, the Department may require an employer to furnish it such documents upon request.
The 15% excise tax applicable to certain large benefit distributions from retirement plans, was repealed entirely for distributions received after 1996.
A qualified retirement plan will not risk disqualification under the Code if it accepts a rollover contribution from another qualified retirement plan merely because the other plan has not received a favorable determination letter from the IRS.
The excise tax on prohibited transactions increased from 10% to 15% per year for transactions occurring after 8/5/97.
Employer tax deductions are disallowed under TRA 97 for certain life insurance contracts, issued after 6/8/97, where the employer is directly or indirectly the beneficiary of the policy. These new restrictions will reduce the attractiveness of broad based leveraged corporate owned life insurance (COLI) to fund ESOP repurchase liability. However, other forms of COLI are still viable for repurchase liability planning.
Two standard ESOP reference books, one for the business audience, the other for practitioners are being updated. Deb Olson contributed the "Employee Buyout Feasibility Study" chapter in the new NCEO book Leveraged ESOPs and Employee Buyouts, and the "Collective Bargained ESOPs " chapter of the forthcoming ESOP Answer Book soon to be published by Panel Publishers as an updated version of the classic Employee Stock Ownership Plans, by Smiley & Gilbert.
In Herman v. Nationsbank No. 95-8934 (11/5/97) the US Court of Appeals for the 11th Circuit decided that ESOP participants who were not informed that unallocated shares would be voted in proportion to the vote of their allocated shares, were not fiduciaries for those unallocated shares. Rather the trustee was the fiduciary for those shares. The participants were fiduciaries for their allocated shares since they were informed of the choices to tender to one of two buyers or not to tender, and that if they did nothing that would be assumed to be a vote not to tender.
In PLR 9733001 (8/18/97) the IRS did not allow an amendment of tax return for a couple who failed to file their statement of §1042 election within their tax return in the year the taxpayers bought qualified replacement property, since the election time limit is set forth in the tax code. Whereas in PLR 9735406 (9/2/97) the IRS was less strict because the missed time limit was a regulatory and not a statutory one. A seller failed to file a statement of purchase when he bought qualified replacement property, but requested a ruling from the IRS before his tax return for that year was due. He remedied this mistake soon after the end of the 30-day filing period, and the IRS found substantial compliance.
Under the 1996 tax law an HCE is defined for plans starting after 12/31/96 as those making over $80,000 per year, any 5% owners during the current or preceding year, or , if the company elects, any employee in the top 20% of compensation. A company would normally elect the "top 20%" rule if more than 20% of its employees make $80,000 + per year, as the "top 20%" election supersedes the $80,000 rule. See IRS Notice 97-45 (8/19/97).