By Mike Staton All too often companies setting up an ESOP (Employee Stock Ownership Plan) concentrate on the legal documents, projections and banking arrangements without considering all of the long-term obligations. Not only do you have the cash flow requirements of the outside loan with the bank or the selling stockholders, you have future Repurchase Obligations to consider in an ESOP.
Repurchase obligations are not required by GAAP to be recorded on the company’s financial statements, so too often they are forgotten until the company has a separation event. The separation event could be an employee retiring from the company or leaving for a multitude of other reasons. The company is required to repurchase the separated employees stock based on the terms of the plan documents, thus setting up the company’s first Repurchase Obligation.
ESOP’s are first and foremost an employee benefit plan. Since the employee’s assets within the plan are primarily stock of the sponsoring company, there has to be a way for the employee to “cash out” of the plan. In a non-public company there is no “market” for the stock to be traded on a daily basis. Therefore, section 409(h) of the Internal Revenue Code requires that the ESOP sponsor company buy the stock back from the employee/owner upon a separation event. The “put” option requires the company to purchase the stock at fair market value from the employee/owner.
Depending on the timing of individuals retiring and turnover, the repurchase obligation can be a very real number to a company’s cash flow requirements in any given year. The plan document may help control this liability, but demographics and the value of the stock also have to be factored into the liability equation.
The IRS code requires that distributions made because of retirement, death or disability begin no later than the end of the plan year that the event occurs. Most plans allow for distributions for terminations or voluntary departures to be delayed for up to five (5) years, or later if the company is still paying on the ESOP loan. This structure can significantly reduce the burden of the repurchase obligation.
This area of ESOP’s can be very complex with numerous other intricacies that can affect the cash flow of a company. Visit Alerding CPA Group’s ESOP web page or call us at 317-569-4181 to find out how we can help you navigate these and other ESOP issues.
This post was written by:
Michael A. Staton, CPA
Mike is a Certified Public Accountant and is Co-Founder and Managing Director of Alerding CPA Group. Mike has served closely-held businesses for over 30 years and was named the Accounting Advocate of the Year by the U.S. Small Business Administration in 2001.
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