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The Employee Ownership Update

Corey Rosen

January 15, 2010

(Corey Rosen)


There has been some buzz lately (again) about something called an "ERSOP" (employee retirement stock ownership plan). Promoters are offering to install these tax-qualified plans, replete with an independent valuation, for as little as $4,000. They claim to have received many determination letters from the IRS approving the approach.

ERSOPs are not something you will find in ERISA. Instead, they are plans in which an executive typically rolls over funds from a 401(k) or other defined contribution plan account at a current or former employer into a new profit sharing or 401(k) plan in a business the individual starts. That lets the individual use pretax dollars to fund the startup.

Some years ago, promoters were saying that the plans could be set up so that only the initial investors would be able to buy shares, but the IRS, at least informally, said this would be discriminatory in the context of a qualified plan. Now the approach is to get securities registration exemptions and offer the shares to other employees in the context of other plan offerings on the assumption that few, if any, will buy them, and that even if they do, they will not buy many. That is probably usually a safe assumption.

If a plan complies with securities laws by getting a registration exemption (there would a few ways to do this for most very small companies), providing an adequate antifraud disclosure statement (most likely including officer salaries as well as a complete discussion of risks), having at least an annual outside appraisal, performing annual discrimination testing, and otherwise complying with ERISA, these plans are allowable. It seems suspicious, however, that all of this can be done responsibly for fees anywhere close to the range these promoters are saying they charge. Independent valuations, even of very small companies, normally start at several thousand dollars,m and disclosure statements are in a similar price range.

So before jumping on the ERSOP bandwagon, get a second opinion from a well-qualified ERISA expert. It will be a very good investment.

Employee Ownership and Congress in 2010

As I noted in my last update, several bills to encourage employee ownership were introduced in 2009. One I did not mention was H.R. 692, introduced by Dana Rohrabacher (R-Calif.). The bill would exclude from gross income any compensation received by employees in the form of employer stock that is held for at least 10 years. It appears aimed mostly at stock grants in public companies.

Overall, the important thing to note is that of all the bills that have been introduced, there is no active legislation or, as far as we know, administration consideration of proposals to cut back on tax benefits for any kind of broad-based employee ownership plan.

The controversy over executive compensation is likely to continue, and legislation requiring say on pay seems likely, but other than that, I think it is very unlikely that Congress will do anything on employee ownership this year. With an already over-full agenda, an election year, and a focus among many legislators, pundits, and even voters on political point scoring rather than actually legislating, this seems like a very safe prediction.

Google and Other Tech Firms' Repricing a Boon to Employees

Last March, Google exchanged more than 7.6 million employee-held options with exercise prices above $500 for options priced at $308.57. Three-quarters of Google's employees were affected. In exchange for a lower strike price, each agreed to a delayed vesting schedule. As I write this, Google stock is worth almost $600 per share. Some analysts say this could create as much as $2 billion in value for employees if they meet the vesting rules and Google stock does not fall again. (Google took a $500 million accounting charge in connection with the repricing.) While Google is the most dramatic case, 15 other technology companies repriced options during the first nine weeks of 2009. Ten of those 16 have seen dramatic gains in their stocks since, according to compensation research firm Equilar Inc. Google, like most of the other companies, restricted the repricing offer to nonexecutives. Because it was more generous than most companies' repricing offers, the Google repricing in particular has annoyed many pundits and investor groups, who argue that shareholders don't get a "do-over."

Estate Tax Changes Could Affect Sellers to ESOPs

The surprise failure by Congress to address the one-year lapse in the estate tax effective in 2010 means that if replacement securities owned by a seller to an ESOP who took a Section 1042 tax deferral on the sale are passed to an estate, they could be subject to capital gains taxes, at least for the portion above $1.3 million. Under the old law, estates were subject to taxation for amounts in excess of $3.5 million as of 2009. But capital gains were "stepped up" on death, meaning that no capital gains taxes were due at that time and a new basis was established as of the value at the date of death. That step-up in basis partially disappears in 2010 for amounts over $1.3 million, or $4.3 million for a surviving spouse. The estate tax and step-up in basis are scheduled to return in 2011.

It is possible that Congress will enact retroactive legislation to address this before 2011.

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