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ESOP Valuations and Fairness Opinions are used to initially independently determine if an ESOP is feasible for a company, and subsequently to establish the worth of a company for ESOP purposes.
ESOP:
Qualified Plan governed by ERISA.
Required to be invested primarily in the sponsoring employer securities.
May be used as a corporate finance technique.
Often used as an exit strategy for a retiring shareholder. The ability for the ESOP to incur debt and the ability for the selling shareholder to reinvest the proceeds on a tax deferred
basis is very attractive.
Creates a market for the stock of a closely held company and make the purchase of that stock a pretax (deductible) expense.
IRC §1042
• Rollover – Allows the seller of stock to reinvest the proceeds from the sale in qualified replacement securities (conditioned on a sale of at least 30% of the company’s outstanding
stock and that the reinvestment occur in the next 12 to 15 months).
• A bank or other lender funds the transaction in order to take advantage of IRC §1042.
Valuation:
Must satisfy the Department of Labor and the Internal Revenue Service.
ESOP specific considerations –
• Adequate consideration
• The effects of leverage and the treatment of debt
• Fair compensation
• Repurchase liability
• Mandatory put option
• Lack of marketability
• Control and minority interests
• Marketability issues
• Using non-voting shares
• Tax deductibility of ESOP contributions
In addition to the employee benefits for all employees, ESOPs are often regarded as the most effective and efficient method for business owners to transfer ownership of closely-held companies. [ESOP = (A) Tax deferred sale of company shares + (B) tax deductible principal loan repayment = (C) happy employees.]
► Family Limited Partnership Reports – helps you efficiently transfer property. This is necessary to obtain appropriate discounts:
Owners of Businesses, Real Estate, and Marketable and non-Marketable Securities can transfer property to their children, grandchildren or favorite charity and significantly reduce
estate and gift taxes.
Parent controls as G.P., child or grandchild or charity is a L.P.
The value of the asset – the limited partnership interest – may be discounted (by an Appraiser) when computing the gift tax.
Theory – the L.P. interests are worth less since the L.P. has no control over the Partnership’s activities and the interests are not marketable.
Use Family Limited Partnerships as a tool for (1) asset preservation, (2) estate planning, (3) family transfers, (4) charitable giving, and (5) income tax planning.
Considerations:
Form the L.P. while the Owner or investor is in good health and has a reasonable life expectancy. Establish the L.P under state law and run it like a business, preferably with a
corporate G.P. that has a Board of Directors.
Consider adult children or independent 3rd parties as G.P. for key decisions to avoid investor having too much control. Mandate distributions of income.
Document the purpose of the L.P. – Show non-tax reasons, such as protection of assets from creditors.
Transfer only business or investment assets – not personal residences or vacation homes – into the L.P.
Give the investor a minority interest, or less than a controlling interest, in the corporation/G.P., to restrict the investor’s ability to dictate how the L.P. distributes income.
The investor/G.P. should not be dependent on L.P. distributions for living expenses.
Document the amount of the gift on the tax return with an appraisal.
► Noncash Charitable Contribution Validation – of Business Interests, Real Estate, and Marketable and non-Marketable Securities require unique valuation considerations.
• Generally, noncash charitable contributions from individuals to charitable organizations (including most schools) are tax deductible at Fair Market Value.
• Determine the FMV of the noncash charitable contributions.
• If the value of the noncash charitable contributions is more than $250:
You must have the noncash charitable contributions substantiated by a contemporaneous written acknowledgment. Generally, the acknowledgment must include the amount of cash and a description of the noncash charitable contributions, and a description and good-faith estimate of the value of any goods or services received for the noncash charitable contributions.
• If the FMV of the noncash charitable contributions are more than $500:
You must fill out Section A of IRS Form 8283HH, Noncash Charitable Contributions.
• If the FMV is more than $5,000, and not all marketable securities held by the entity making the gift:
You must have an appraisal done, and also fill out Section B of HH IRS Form 8283HH, and attached to tax return.
The Business Appraiser must comply with the IRS requirements of appraiser certification.
Have a question on Business Valuation? Contact Michael Gilburd.
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