RSM McGladrey ESOP Blog

Did you know this about Code Section 409(p)?

I don’t think we have discussed this particular issue previously – Code Section 409(p) – that complicated test that we have been talking about for what seems like forever is a daily test. That means it has to be satisfied on each and every day of the year or those nasty penalties will apply.

Your first reaction may be  - “that is no big deal, there are no changes in our ESOP balances except for once per year, on the last day of the year.”

But remember that the 409(p) testing also includes synthetic equity arrangements and ownership outside of the ESOP.

So what if you issue new synthetic equity during the year?

What if the ownership outside the ESOP changes – maybe one shareholder sells to another?

What if two of your employees marry during the year and create a family group that now needs to be tested?

Each of these things could impact the 409(p) test as of the day that it occurs. 

How cool is this?

Innovative Collaboration Creates Largest Online Library of University Teaching Materials on Employee Ownership

I know that when I was in college, I never dreamed that I would be working with employee owned companies because I had no idea what an ESOP was at that time.

I also like that there is a centralized library of information that folks can access – I know there is a lot of information out there currently but finding it can be tricky sometimes.

Maybe my recent musings on Code Section 409(p) will make it into this library – just teasing! But I will be back soon with some more interesting tidbits on Code Section 409(p).

It is one week until Election Day!

I, for one, cannot wait for the end of the phone calls!!!! 

I realize that there are many issues to consider when voting for elected representatives at all levels but if you are passionate about employee ownership and ESOPs, it would seem that a person’s position on these issues should factor into your vote.

In my post on October 20th, I mentioned that I thought all ESOP companies should belong to the NCEO, The ESOP Association and if an S corporation to ESCA. One of the benefits of membership in these organizations is that they keep you abreast of current events impacting ESOPs and that includes disseminating information on which elected representatives have been particularly supportive of ESOPs. For example, if you are a member of The ESOP Association, you would have access to this article - Clear Cut ESOP Champions in 110th Congress: 2007-2008

So don’t forget to vote and once the election is over, call the offices of your elected representatives and let them know that their support for employee ownership or lack thereof impacted your vote and will likely do so in the future!

We need to return to our discussion of Code Section 409(p) synthetic equity arrangements.

We do need to get back to our discussion of the Code Section 409(p) synthetic arrangements. I wonder if you had the same question that I originally had when the IRS told us that we did need to include the present value of any nonqualified deferred compensation plan as synthetic equity - how do we determine the present value of the nonqualified deferred compensation arrangement?

I bet you are thinking that since the IRS has taken the time to lay out these very complicated tests under Code Section 409(p), that they would also have been very specific in terms of the present value calculation. Because the interest factor chosen to make the present value calculation can significantly impact the result, surely the IRS gave us some guidelines so that we know that our choice will be deemed appropriate by the IRS?

No, the very extensive regulations offer no guidance on the present value calculation so your advisors will have to choose an interest rate that is reasonable based on the facts and circumstances. And speaking as one of those advisors, that flexibility can be a good thing but the lack of certainty is can be unsettling.

 

What kind of an accountant am I ….

When I apparently cannot count?  I reported here on Friday that there were four ESOP companies were named in list of the 2008 Best Small Workplaces. Well, it turns out that there were really five. 

As an ESOP company, you should follow the advice of Corey Rosen of the NCEO and consider applying for the award – Five of the 15 Winners of Wall Street Journal/Winning Workplace Top Small Workplaces Have ESOPs

Also, this is unrelated but we were just talking about this at an internal team meeting today – if you are an ESOP company and are not members of the NCEO, The ESOP Association and if an S corporation, the Employee Owned S Corporations of America (ESCA), then you should strongly consider joining all these organizations.  We see the benefits to our clients who are members and decided just today that it was once again time to reach out to our non-member clients to encourage them to join!

Congratulations to these 4 ESOP companies

This is somewhat old news but I want to end another trying week on the economic front with some good news - Four ESOP Association Members Named 2008 Top Small Workplaces

Congratulations!!!!!!!!

Senator Grassley meets with several Midwestern ESOP companies

Back in late August, I had a couple of posts here reporting on the visits by certain members of Congress to ESOP companies.

Well, I got to be a part of one of those visits myself yesterday. Senator Charles Grassley visited Inland Truck Parts & Service here in Des Moines. FYI - Senator Grassley happens to be the Ranking Republican on the Senate Finance Committee so he would see any legislation that would impact ESOPs.

I really enjoyed this event. Of course, I appreciate the willingness of Senator Grassley to visit this company and talk to the employee owners of Inland Truck as well as the employee owners of several other ESOP companies. But I have to tell you, it was the passion for ESOPs and employee ownership exhibited by those employee owners that moved me.

Sometimes I think about how lucky I am that my career took a direction that led me to become an ESOP consultant. While there are many times that I am jealous that I do not work for an ESOP company, I am honored to be an advisor to many ESOP companies and to be able to assist other companies as they consider an ESOP. 

Yesterday was a good day for this particular ESOP advisor!

I try to avoid most political discussion in this blog...

I realize that many blogs are devoted to politics but mine is devoted to ESOPs and employee ownership. But my background includes work with 401(k) plans and most of my clients have both an ESOP and a 401(k) plan so I have to comment on something that I heard being proposed by Senator Obama.

While I was pleased by Senator McCain’s proposal to at least temporarily suspend the silly rules that require that distributions from most retirement accounts begin at age 70 ½, I am not as wild about Senator Obama’s latest proposal - Relax rules on early withdrawals from retirement savings.

My first concern is that by taking an early withdrawal, a person may be converting a paper loss into an actual loss. I am sure the gains in the market today may help recoup some of those paper losses.

But still, should we be encouraging folks to raid their retirement funds to help with today’s financial crunch? Especially when we already suspect that folks simply are not saving enough for retirement?

What a week!

After trying to digest all of the bad economic news this week, I cannot make myself continue my writings on Code Section 409(p), synthetic equity arrangements, etc.

So instead I thought I would share this small piece of possible good news – John McCain proposed suspending the requirement that investors begin dissolving their IRAs and 401Ks soon after age 70,

I presume this would apply to ESOPs as well. I am not sure that the age 70 ½ distribution rules are all that significant for ESOPs but they sure can be a nuisance.

So how do you determine how many shares of synthetic equity to include in your Code Section 409(p) calculation?

I am sure that some of you were wondering this – how did I make the calculation that determined that a nonqualified deferred compensation arrangement in our example from last week resulted in 75 shares of synthetic equity?

As with everything with Code Section 409(p), the answer will take some time.

First, the determination of what I will call the “gross synthetic equity” will depend upon the type of the synthetic equity. For example, one stock option would usually give the employee the option to buy one share of stock at a predetermined price at some date in the future. So one stock option would equal one share of gross synthetic equity.

A stock appreciation right usually gives the holder the right to a cash payment equal to the appreciation in the value of a share of stock from one date to another. So if the stock value increased from $50 to $100, then the appreciation is $50. That $50 would be divided by the current share price of $100 and would create 1/2 of a share of gross synthetic equity.

For a nonqualified deferred compensation arrangement, you would take the present value of the benefit to be received by the employee and divide that dollar amount by the current share price to determine the number of shares of gross synthetic equity. 

But there is another step to the calculation. The number of shares of synthetic equity is reduced proportionately if the ESOP owns less than 100% of the S corporation.

So in my example from last week, I ended up with 75 shares of synthetic equity. Here is how I got there:

The present value of the benefit under the nonqualified deferred compensation arrangement = $15,000
The current fair market value per share = $100
The number of shares of gross synthetic equity = 150
The percentage ownership of the S corporation by non ESOP shareholders = 50%
The net number of shares of synthetic equity to include in the calculation = 75

That seems pretty straightforward right? Well, let’s talk about some complicating factors in a future post.