RSM McGladrey ESOP Blog

Diversification season has arrived!

If the plan year for your ESOP is the calendar year, then you will likely be entering diversification season soon. So I thought it might be a good idea to do a series of posts to update you on the basics of diversification. Of course, like every other ESOP issue, there are some gray areas and we are getting word of another strange IRS position on diversification.

But first the basics – the theory behind the diversification requirement is obvious. As an employee nears retirement, it may make sense for him or her to be able to diversify out of the company stock holdings and into something more stable.  (I am not sure what that investment would be in this current environment – maybe stashing cash in a coffee can and burying it.  But these times are unique and hopefully will be ending soon. )

The Internal Revenue Code provides that an ESOP participant who has 10 years of participation in the ESOP and who has attained age 55 must be able to elect to diversify 25% of the balance in his or her company stock account. This election must be provided annually for 5 years after the participant meets both the service and age requirements. Then in the 6th year, the participant can elect to diversify 50% of his or her company stock balance.  Then, unless your plan includes more liberal diversification provisions, the diversification election period ends.

That all seems pretty straightforward doesn’t it?

But wait, how do you define a year of participation for this purpose? How and when do you notify employees of their right to diversify? How do you calculate the 25% in years 2-5? Do former employees who are receiving installments payments also have the right to diversify? Do we need to offer mutual funds or other investment alternatives in the ESOP for someone who elects to diversify?

I will attempt to answer these questions in future posts but I am pretty sure that I will be raising more questions as well. 

Employee Owned Companies Continue Their Winning Ways

You just have to love this headline - Employee-Owned Companies Abound on Fortune Magazine's Top 100 List for 2009

Some advice for our new President

I thought these words from J. Robert Beyster were definitely worth sharing -

"Here is my recommendation for getting out of our current economic mess and returning to prosperity: create a culture of growth based on employee ownership. Now more than ever we need to make employees true partners in our businesses. Study after study shows that employee-owned companies perform better than companies that are not. Widespread employee ownership will have a huge, positive impact on our economy.

Creating a culture of growth requires leaders to remove the organizational obstacles that get in the way of moving quickly to take advantage of changes in the marketplace. In some cases, these may be procedures and practices that have served the company well in good times, but that threaten to bog the company down in bad times. Hire smart people and then put your trust in them. Give them a stake in the business that they contribute to, and unlock their energy and ideas. Create an entrepreneurial culture, where employees have wide-ranging autonomy and authority, and are rewarded for finding and capitalizing on new opportunities for growth. And don’t be afraid to experiment, and try new combinations of people and organizational structures."

A Significant First

Congratulations to Radian Research, Inc. on becoming a 100% employee owned company. And Radian did so by being the first company to participate in Indiana’s ESOP Initiative (IEI) Linked-Deposit Program.

Through the ESOP Linked-Deposit Program, the Treasurer of State’s Office will purchase certificates of deposit at a reduced rate of interest from the financial institution providing the loan to the ESOP company, and, in turn, the financial institution will reduce the interest rate on their loan to the ESOP company.

Why would Indiana sponsor such a program? The President of Radian has the answer-

"It's likely, if the company had been sold to a third party, that the jobs would have left the community," he said. "We have good paying jobs at our company, and we expect to keep growing."

Wouldn’t it be great if more states followed the lead of Indiana!

State Announces First ESOP Participant

Local company becoming employee-owned

Radian turns ownership over to employees

How will the economic crisis impact the value of your ESOP’s stock?

Let me start by saying that I am not a valuation expert so I am not going to pretend to know the answer to that question.

But I am fortunate enough to know some really smart folks, including the experts from Chartwell Capital Solutions. Here is a really great piece that they put together on this very subject (starting on page 2) - Economic and Market Turmoil: What Impact Does That Have on My Business?

What percentage of your employees truly understand “ownership?”

I read this piece over the weekend - Osborne Industries' employees take stock of business
company

That article includes this piece of information - "Owners wake up at 2 o'clock in the morning wondering how to make things better. I would say 20 percent of them are doing it. They're truly committed to success," he said, "and another 30 percent are on board."

So of course that leads me to wonder what percentage of the employees at your company understand the concept of ownership and hence act as an owner would act?

Here is another reason to nominate your company for a 2009 Top Small Workplace award

I have had many conversations with clients recently about what to expect in 2009 and the coming years in terms of legislation impacting ESOPs. The question comes from uncertainty due to a new Administration, some negative press on ESOPs stemming from the Chicago Tribune and the economic situation that may cause some ESOP companies to struggle.

Of course, I have no idea what to expect from our elected officials in Washington. 

I do know that while any bad news involving a company with an ESOP will most likely make the headlines, the good news stories go largely unreported.

If an ESOP company were to win an award as a 2009 Top Small Workplace, it will be reported in The Wall Street Journal. That type of positive press is exactly what the ESOP community needs. Congress will be less likely to enact legislation that would be negative to ESOPs if there are more ESOP good news stories in their newspapers.

So here is the link to the nomination form again - Nomination Form – 2009 Top Small Workplaces

And the winner is……..

Did you watch the Golden Globes this past Sunday evening? I missed it but saw plenty of highlights replayed. Wouldn’t it be cool if your company could win an award as an exceptional organization?

Well, maybe you can.

Winning Workplaces and The Wall Street Journal are collaborating to identify exceptional small organizations – private, nonprofit or publicly held – in their third annual ranking of the Top Small Workplaces. They will be selecting small employers that foster teamwork, flexibility, high productivity and innovation while also helping their employees grow personally and professionally, and providing them benefits that improve their lives and communities.

An eligible candidate is a North American organization that:
• is independent - not a unit of a larger corporation
• has no more than $200 million in annual revenues
• has 500 or fewer employees
• has been in business at least five years

Wouldn’t it be cool to be recognized in The Wall Street Journal as a winner? And think of what you might learn about your company by going through this process.

The nomination process is easy. Here is the link – 

Nomination Form – 2009 Top Small Workplaces

Oh and the nominations are due by 1/30/09 so don’t dawdle!

Is there any type of Form 1099 reporting of the sale of shares distributed from an ESOP?

While many of my clients now make distributions from their ESOP in the form of company stock, in most cases such stock is immediately sold back to either the company or the ESOP.

When I sell a stock in my brokerage account, I receive a Form 1099B from my brokerage firm? So if your company is buying the shares back from former ESOP participants, do you need to issue Forms 1099B to all such former participants?

I am sure this will not surprise you but the answer is not clear. The instructions to Form 1099B indicate that it must be filed by “brokers” and goes on to indicate that a corporation that regularly redeems its own stock is a “broker” while a corporation that purchases odd-lot shares from its stockholders on an irregular basis is not a “broker.”

So filing the Forms 1099B may be the safest answer as even if it is technically unnecessary, there should not be any adverse consequences of such filing.

Are you preparing Forms 1099R correctly?

I thought that I would repeat and update a post from approximately one year ago as the deadline for filing Forms 1099R again approaches. 

Many of our clients have changed the form of the distribution so that company stock is actually distributed to the former participant (usually subject to an immediate and mandated put of such shares back to the company or the ESOP.) The reporting of a lump sum distribution of company stock will be different than the reporting of a lump sum cash distribution (note, the following would not apply to an installment distribution.) 

The fair market value of the shares will be reported in box 1 of Form 1099R.  The net unrealized appreciation (NUA), which is the excess of the fair market value of the shares over the cost basis, will be reported in box 6 of Form 1099R.  Assuming that there is not a direct rollover, the cost basis of the shares distributed will then be reported in box 2a.  (This all assumes that the fair market value of the shares exceeds the cost basis – if the fair market value is less than the cost basis, there is no NUA to be reported.)

Note, if the distribution consists of shares of stock of an S corporation, the IRS has indicated that the cost basis of the ESOP’s shares must be adjusted in the same manner as would apply to the basis of a non-ESOP shareholder. There is some uncertainty as to how to allocate this basis adjustment among the ESOP participants so you should consult with your ESOP advisor on this issue.

Another question that may arise is if there is any reporting required of that immediate sale of the stock back to the plan sponsor? More next time on that.