A: A PEO employee working for a client organization (CO), also known as a “worksite employee,” is often considered a common-law employee of the CO when the worksite employee works full-time at the CO, is under the CO’s control, and does work normally done by the CO’s employees. If a PEO’s defined contribution plan (such as an ESOP) covers worksite employees who are common-law employees of the COs where they work, the plan can be disqualified because it violates the exclusive benefit rule (which provides that the plan trust must be for the exclusive benefit of employees of the sponsoring company).
In Revenue Procedure 2002-21 (amplified in Revenue Procedure 2003-86), the IRS stated that to prevent disqualification, PEOs could either terminate their single-employer defined contribution plans or convert them to multiple-employer plans. However, ESOPs cannot be multiple-employer plans, so it is doubtful that a PEO can have an ESOP that covers worksite employees.
A: An LLC is an entity sanctioned by most states that combines the attributes of a subchapter S corporation and a partnership. Like an S corporation or a partnership, taxes are passed through to individual owners. Because LLCs do not have stock (rather, they have membership interests or units), they cannot have ESOPs, stock options, or other stock-based plans. However, LLCs taxed as corporations can have an ESOP.
A: There are a lot of things you can do. Showing numbers can help, but people relate to stories even more. If you know of any local ESOP companies that have been employee-owned for some years (contact us or your service provider for suggestions if not), ask them if they have any employees who might be willing to share their stories about what the ESOP has meant to them. It could be a short video, a written response, or even a presentation. We also have some videos along those lines on our sister website esopinfo.org. Visit this link to see these videos.
Another idea is to set up an ESOP calculator, ideally one where employees can put in some realistic alternative scenarios for how much the company contributes (you can tell them that number) and how stock price will grow. An ideal calculator factors in forfeitures, too.
Some plan administrators can provide these calculators, and there are also non-administrative firms that have tools anyone can purchase (search for ESOP calculators online to find a number of these).
Finally, the NCEO has extensive data showing how ESOP employees fare in general compared to non-ESOP companies (spoiler alert: a lot better).
A: Legally, the ESOP administrative committee must make any decision as to the voting or tendering of shares (other than those for which the plan provides a pass-through to participants) based on the best interest of plan participants. In other words, the ESOP committee (or any other fiduciary) cannot consider the employment interests of participants. Instead, the ESOP administrative committee must look to the long-term value of the accounts in the plan. Many consultants would argue that it may also consider the preservation of employee ownership as part of the legitimate interests of participants, provided this is spelled out as a plan purpose. The ESOP administrative committee cannot make a decision that is primarily for the benefit of other parties, such as management or other owners.
Even where the employees direct the voting or tendering of shares, however, there is disagreement on whether the ESOP administrative committee (or another fiduciary) can simply follow these instructions (and, if so, when).
A: The employer does not have to sell stock to cover the withholding requirement. Basically, this means the employer must withhold the lesser of 20% of the distribution amount or the total that is not in the form of employer securities. For instance, assume an employee has a $20,000 account balance, all in stock. In this case, no withholding is due. If the balance were $16,000 in stock and $4,000 in cash, the entire 20% would be withheld. If only $2,000 were in cash, 10% of the $20,000 would be withheld. If, however, the plan actually cashes out the employee, translating the stock into cash before distribution, the entire balance is treated as a cash balance.
Just to make things a bit more complex, the withholding rules apply only to the immediately taxable portion of the distribution. If an employee receives a lump-sum distribution partly in stock and partly in cash, the immediately taxable portion is the cash plus the lower of the cost basis of the shares (the ESOP’s original purchase price) or its current value. Unrealized appreciation is only taxed when the stock is sold. For non-lump-sum distributions, the total market value of the stock at the time of distribution is used to calculate the amount that must be withheld. However, the amount that can be withheld is still subject to the maximum limitation of how much cash is in the distribution to the employee.