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The Employee Ownership Update

Corey Rosen

May 1, 2007

(Corey Rosen)

Value of Stock Options Grants Declines

A new survey from Watson Wyatt Worldwide found that the value of stock options (based on the Black-Scholes formula) dropped 71% between 2001 (its peak) and 2005, falling from $137 billion to $40 billion. The value of options declined 32% just from 2004 to 2005. The value of grants per company declined by 33%.

Transfers to Grantor Trusts Maintain QRP Status

In PLR 200709011 and PLR 20079012, the IRS ruled that the transfer of qualified replacement property (in the context of a Section 1042 ESOP transaction) to a grantor retained annuity trust (GRAT) does not constitute a disposition of the QRP. In the second ruling, the IRS also ruled that the contribution by the GRAT of QRP to a charity would not constitute a disposition. GRATs are trusts designed to provide the grantor with an annuity income until death, at which time the income would go to the beneficiaries. The trust mechanism avoids any transfer taxes unless the donor dies before the end of the trust term.

In these rulings, the IRS said that as long as the grantor retained control of the trust in a nonfiduciary capacity, and did not subject the decisions to anyone in that capacity, then the transfer would not be a disposition, that cash or other QRP could be substituted by the grantor for the assets held in the trust, that annuities paid would not constitute a disposition, and that if the owner dies during the trust term, there will be no recapture of gain. Note that these rulings do not mean that the person selling to the ESOP can avoid paying capital gains taxes when the shares are sold within the grantor trust.

Newsweek Columnist Bashes S Corporation ESOPs

Newsweek columnist Allan Sloan wrote in the May 7 issue that the use of an ESOP in the Tribune Company transaction is not what Congress had in mind. He quotes the legislation's sponsor, former Senator John Breaux (D-LA) as saying that "I wanted to encourage employee ownership...I wasn't trying to encourage tax avoidance." Sloan portrays the S corporation ESOP rules as just another "tax dodge." He says the provision was "slipped in" to the Minimum Wage Act (actually, it was part of a broader reform of S corporation rules that became part of that law) and, in commentary on the NPR program "Marketplace," urged Congress to repeal the law.

It is debatable whether ESOPs really are tax avoidance. The way an S corporation works in the first place is that earnings are only taxed once at the level of the individual owners. If the ESOP trust is taxed, and then the individual employees are taxed when they receive a distribution, then earnings would effectively be taxed twice.

Google, W.L. Gore Leaders Share Keys to Employee Involvement

At the recent 2007 Great Place to Work conference, Google Director of HR Laszlo Bock reported that the company had one million job applications last year. Google was the top company on the Best 100 Companies to Work ForŪ list. Notable among Google practices is providing up to 20% of an employee's time to pursue any project of potential interest to the company and themselves. By leaving this time free, the company believes, employees are more likely to be creative than if every hour of every day is structured. Google gives all employees ownership in the company.

W.L. Gore and Associates, an ESOP company (number seven on the list) disdains traditional management styles altogether. Instead, when associates have ideas, they are allowed to pursue them, provided they can get enough other associates to go along and join their team. CEO Terri Kelly says this process is much more rigorous than traditional approaches that give management the ability to approve ideas (and may not even encourage employees to submit them), while also generating a lot more ideas than management would ever do on its own.

Author biography and other columns in this series

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