Academic journal article Journal of Accountancy

Reinvigorating Aging ESOPs

Academic journal article Journal of Accountancy

Reinvigorating Aging ESOPs

Article excerpt

What can a plan sponsor do to cope old age?

Many employee stock ownership plans (ESOPs) created over the past 20 years are experiencing the pains of old age as tax and other projections diverge from the original plan designs. To solve these problems, ESOP sponsors must carefully consider possible corrective action--including reloads, refinancings, grantor trusts (and even possible plan terminations) as well as tax and accounting changes--to arrive at a solution that best serves the company and participants, all while complying with ERISA and the IRC.

Companies created leveraged ESOPs in the late 1980s and early 1990s, borrowing funds to purchase company stock. In the intervening years, the plans repaid the stock acquisition loans and released shares to participant accounts. As these loans near the end of their terms, employers face new problems if these plans are to continue in the future. This article focuses primarily on issues of interest to large employers, many of which are public companies. Other concerns that confront private company ESOPs exclusively--S corporation ESOPs, IRC section 1042 transactions and valuations issues among them--are not addressed because much has been written about them elsewhere.


For most people, hostile takeovers, junk bonds and ESOP leveraged buyouts (see the sidebar on page 53) seem largely a relic of another age. When LBOs and hostile takeover activity slowed in the early 1990s, the creation of new large ESOPs by companies trying to block or facilitate takeovers slowed as well. Since then, family-owned businesses have used ESOPs as devices to sell the businesses through tax-advantaged section 1042 sales. More recently, small businesses have employed them to reduce taxes through the use of ESOP-owned S corporations.

Many older ESOPs are drawing attention again as the loans the plans used to acquire stock come due. Much of the debt had a term of 10 to 20 years. For example, for exempt securities acquisition loans relying on the 50% interest exclusion under IRC section 133, loans made after July 10, 1989, were limited to 15 years (subject to certain grandfather rules). Loans using the "principal only" method of allocating shares to participants were subject to a 10-year maximum term under Treasury regulations section 54.4975-7 (b) (8)(ii).

As ESOPs move forward to meet the needs of a new generation of employees, plan sponsors, and the CPAs and financial managers who advise them must consider the accounting and tax changes that have an impact on plan operations. Those companies that decide they want to continue to use ESOPs to promote employee ownership must then decide what techniques they will use to finance and acquire shares as they make the transition to the future.


The AICPA changed the accounting for ESOPs by issuing Statement of Position 93-6, Employers' Accounting for Employee Stock Ownership Plans, in 1993. Previously, a company charged the amount of an ESOP contribution to expense without regard to whether it used the contribution to pay down an exempt loan to release shares. SOP 93-6, however, generally provides that when a company allocates shares to participants' ESOP accounts, a compensation expense results that is measured by the fair market value of the stock on the allocation date.

Under SOP 93-6, a company treats dividends on stock held in an ESOP the same as dividends on non-ESOP shares if the stock is allocated to participant accounts, reducing retained earnings. If the dividends are paid on unallocated shares, the company treats them as

* A reduction of the principal or interest on the exempt loan if it uses them to repay the exempt loan.

* Compensation expense if the company allocates the dividends to participants' accounts or if it pays them to participants out of a suspense account.

Previously, under SOP 76-3, Accounting Practices for Certain Employee Stock Ownership Plans, a company treated dividends paid on ESOP shares the same as those paid on non-ESOP shares. …

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