The cost basis of any type of stock is essential to recordkeeping. It’s needed to calculate and document any gain or loss in share value, as well as the timing of that gain or loss, for tax purposes.
One vitally important strategic planning process that’s sometimes put off by business leaders, especially at closely held companies, is succession planning.
Effective succession planning helps protect your company from the worst outcomes, should something unforeseen happen to any key employee—but it does more than that. By following specific succession planning steps, your leadership team can:
- Identify and develop future leaders
- Create attractive career paths
- Address training needs
- Reduce recruiting costs
- Protect and retain institutional knowledge
- Break down departmental silos
- Build company culture and improve employee morale
Early on in the pandemic, 90% of executives surveyed by McKinsey & Company said they thought COVID-19 would lead to fundamental changes to business. Leaders across industries saw these pivotal changes as a growth opportunity. Yet at the same time, only 21% felt prepared for the challenges involved to grasp it.
This urgent need for innovation and creativity points to a potentially huge moment for employee stock ownership plan companies that embrace an employee ownership culture. Why?
When employees engage deeply with the vision and mission of the business, and when leadership shares information to help workers understand how their contributions support a stronger future, that creates a growth culture — even in challenging times.
Whether your employee stock ownership plan (ESOP) is new or your company has been employee-owned for years or even decades, an ESOP communication committee is an important part of your plan.
Just as no two ESOP companies are alike, your communications committee is unique to your company and the employee-owned culture you create.
ESOP committees do much more than plan company-wide cookouts and celebrate Employee Ownership Month with games and giveaways. They serve as a key resource to educate and improve employees’ awareness of employee ownership retirement benefits, and how your ESOP works.
Improved ESOP awareness fosters a sense of shared purpose, which can convert plan participants into advocates — and that can impact not only company performance and ESOP share price, but also your recruiting and retention efforts.
Often, when business owners begin investigating exit strategies and discover the benefits of an employee stock ownership plan (ESOP), they’re running companies without a board of directors in place.
In fact, it’s common for the business owner to essentially serve all board responsibilities, while also serving as president and/or chief executive.
Other companies may have a board in place that doesn’t actually fulfill the responsibilities of a board of directors. Instead, they’re often operationally focused, making shorter-term business decisions rather than governance decisions with a longer-term, strategic focus.
But making the transition to an ESOP company changes more than the ownership of the business. ESOPs are subject to the Employee Retirement Income Security Act of 1974 (ERISA), which describes fiduciaries and their obligations to ESOP shareholders (in other words, employee-owners).
An employee stock ownership plan (ESOP) is subject to requirements of U.S Code §401 covering qualified retirement plans.
Section 401(a)(28)(C) requires that “all valuations of employer securities which are not readily tradable on an established securities market with respect to activities carried out by the plan are by an independent appraiser.”
This means that to ensure that the ESOP and ESOP-sponsoring company continue to qualify for an ESOP’s substantial tax benefits, your ESOP appraiser needs to demonstrate and declare his or her independence.
Section 409(h) of the Internal Revenue Code requires that an employee stock ownership plan (ESOP) participant can demand that their ESOP benefits are distributed as employer stock. It also states that, if those shares “are not readily tradable on an established market, [the participant] has a right to require that the employer repurchase employer securities under a valuation formula.”
This section provides the “put option” that creates the ESOP repurchase obligation (also called the repurchase liability), or RO.
A closely held ESOP company is required to buy back distributed shares from ESOP participants according to the company’s ESOP plan document and ESOP distribution policy.
All this is because an ESOP is a qualified retirement plan. Employees anticipate using distributions to help fund their retirement, so a lot of the benefit’s value rests in employees’ being able to count on payment after distribution. The significant tax benefits of an ESOP are designed to facilitate the employer’s repurchase of participants’ shares.
Along with other employers that offer benefit plans covered by the Employee Retirement Income Security Act of 1974 (ERISA), companies that sponsor employee stock ownership plans (ESOPs) are required to file Form 5500, Annual Return/Report of Employee Benefit Plan.
The Internal Revenue Service (IRS) stipulates a due date of the last day of the seventh month after the plan year ends. So if your plan year is a calendar year, that means Form 5500 is due July 31 of the following year.
IRS Form 8955-SSA, Annual Registration Statement Identifying Separated Participants with Deferred Vested Benefits, shares a due date with Form 5500.
Plan sponsors can request a one-time extension for up to two and a half months by filing Form 5558, providing you meet the required conditions.
Here’s what you need to know to file this request for an extension of time to submit IRS Form 5500 and/or IRS Form 8955-SSA. This filing extension is typically required when an extension is needed for the employer’s annual federal income tax return.
Over their years of work at a company that sponsors an employee stock ownership plan (ESOP), participants accumulate stock share allocations in their ESOP accounts.
An ESOP is designed so that when a vested participant leaves the company, the value of the ESOP account is distributed to that former employee. The ESOP trust (or company) repurchases the employee’s shares and the employee receives payment, which they can choose to roll over into an individual retirement account (IRA) within a stipulated time limit, or pay income tax (along with an additional 10% excise tax if under age 59-½) and use as they would any other income.
The payout process is determined by the ESOP document and the distribution policy effective for the plan. In most cases, when an employee terminates, they must start receiving their distributions in the year that follows termination, and distributions must be completed within five years, as substantially equal payments that take place at least annually. Distributions of very large ESOP balances can be extended even longer.
One critical aspect of every business plan that few entrepreneurs and business owners consider in advance is an exit strategy.
It may seem counterintuitive to focus on your exit strategy while running a business, but without it, you don’t have a path for transfer of ownership. That means no plan for how you’ll achieve your return on your investment — at least the financial investments you’ve made in your startup or small business.
As an entrepreneur, small business owner, or startup founder, what are your options?
Most startup founders and small business owners are well aware of some of the flashier ways to sell a business: the initial public offering (IPO) and the acquisition get a lot of attention. But those aren’t the only business exit strategies, and they may not be good options for every entrepreneur.
