Pros and Cons for S-Corp ESOP

[kwalified]

A small C-corp bank maintains an ESOP. They have been considering changing to a S-Corp and are interested in knowing what affect this could have on their plan. Outside greater scrutiny by the IRS and/or DOL due to pass through issues, what other pitfalls could they face? Would the benefits of changing to an S outweigh their current structure as far as their plan is concerned?

[GMK]

First two things that come to mind:

1. Dividends paid on stock in the ESOP go into the participants' ESOP accounts (cannot be passed through to participants).

2. Pass-through earnings to the ESOP are not taxed, of course, but are added to the basis of the stock in the ESOP. This is not too tough to do, but it's an added administrative task.

[A Shot in the Dark]

I would make sure that you and your client have a very good understanding of the provisions American Jobs Creation Act of 2004. Since the passage, most of the community banks that we provide ESOP services to, have chosen to elect "S" status.

[jpod]

Complexities of IRC Section 409(p).

[ESOP Guy]

It might depend on how what percentage the ESOP owns of the company.

Also depends on how much of the companies taxable income currently is paid as contribuitons and dividends. But if those two are most of the taxable earnings you can get a dedcution for the contributions and done right for the dividends.

A good ESOP TPA could help you with this kind of anlysis. I normally don't plug myself on this board but in this case e-mail me if interested. ESOPs are pretty much all the firm I work for does.

As others say need to look to 409(p) carefully if you have a few large owners and/or synthetic equity. If you are leveraged and currently have large loan payments with a C corp your interest most likely doesn't count towards many of the limits. That is not true for S corps. So to get large amounts of cash into the plan you will be more dependent on dividens (S corp distributons).

Those are the quick thoughts.

[RLL]

There are many complex tax and other regulatory issues involved in having a bank elect S corp status. For example, certain banks are not eligible to elect S corp status.

You can't expect to get sufficient guidance in a forum such as this. The folks here don't know the specific facts involved in your situation.

With all due respect to ESOP Guy, a "good ESOP TPA" is not qualified to provide advice on the myriad of legal issues that should be addressed as part of this analysis. You should consult with counsel who is familiar with applicable banking regulations and S corp tax matters, as well as ESOPs, in order to properly evaluate this.

[Belgarath]

I think RLL's statemnent is rather broad, even though I don't disagree that counsel may be required. First, many TPA's already have one or more attorneys on staff, who may be very knowledgeable regarding some of the issues mentioned. Second, any good TPA knows what they can help with, and what they can't. On those issues they can help with, they are probably far more knowledgeable than the attorneys, and on those issues that require legal counsel, or CPA input, or a valuation expert, or whatever, they refer the client to appropriate experts. And it works both ways - often the attorney or CPA refers their client to the TPA on questions. "Good" experts in any discipline know their limitations and don't let their egos get in the way of doing the best thing for the client.

Anyway, from my own perspective, ESOP's are a tricky specialty, and it is very possible or likely that outside experts may be required, so that point that RLL makes is well taken. Just don't automatically assume that the TPA firm lacks the qualifications/resources - and I do think a good TPA can be an excellent starting point, as they can focus the discussion and issues, and often in a more cost-effective manner than starting with legal counsel at the outset.

[kwalified]

Thanks for the comments:

The plan owns appx 14% of the common shares, it is non-leveraged and their main concern is to provide the liquidity to cash out participants without having a negative impact on their earnings or capital. I'm thinking an emerging liability study would be a useful tool in forecasting future outlay.

[Guest stanlipton]

Can someone recommend a good resource for a pension consulting/admin firm to learn about esops

[ESOP Guy]

Start by going to either an ESOP Association or an NCEO conference. They have large national conferences and regional conferences.

The ESOP Association conferences are larger then the NCEO's conferences. Either one will have breakout sessions from basic to advanced topics are presented. I would add if you join the NCEO just about every week in the spring and fall they have one hour webinars that are free to members. It also counts as CPE if you have people that need CPE.

Both groups also sell a good number of publications.

Those are your best bet to get pointed in the right direction.