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ESOP POWER An Advanced Planning Strategy For For Private Corporations Presented by: ATI Capital Group, Inc.
ATICG © 2002ATI Capital Group, Inc.2 What is an ESOP ESOP = Employee Stock Ownership Plan An ESOP is a QUALIFIED PLAN under the Employees’ Retirement Income Security Act of 1974 (ERISA) See Sections 401(a), 4975(e)(7), and 501(a) of the Internal Revenue Code of 1986, as amended, and Section 407(d)(6) of ERISA, 1974
ATICG © 2002ATI Capital Group, Inc.3 Unique Features of ESOT An ESOP trust “ESOT” has three very unique features: 1.ESOT must own “principally” stock in its sponsor company. 2.An ESOT is the ONLY qualified plan under ERISA allowed to BORROW MONEY!! 3.The trust can purchase the Company in “Stages” (multiple transactions).
ATICG © 2002ATI Capital Group, Inc.4 Powerful Use #1: Exit Strategy ESOP $ Loan 2 Stock $ 3 QRPs Sec Qualified Replacement Property= Stocks & Bonds Div’d $ $ 4 5 Collateral No Tax on Transaction Company Deducts Princ. On Loan Lender The Basic Transaction Corporation 1 $ Loan
ATICG © 2002ATI Capital Group, Inc.5 Benefits to the Corporation 100% deductibility of PRINCIPAL and interest on ESOP loan to buy-out Shareholder. Increased cash flow due to deductibility of principal on loan. 100% deductibility of DIVIDENDS paid to reduce ESOP debt or distribute to participants. Collateral for ESOP created outside company. Preferred terms on ESOP loan. Principal shareholder bought out for $0.66 dollars, compared to $1.52 dollars.
ATICG © 2002ATI Capital Group, Inc.6 How to Deduct Principal Under ERISA Results: Tax Deductible Principal & Interest Assumptions: $10,000,000 ESOP transaction Terms: 8% APR; 10 yr. Amortization Monthly P + I = $121,328 Lender Step 3 Co. makes payment to lender $121,328 Step 2 ESOP makes mirror payment on Note Payable to Co. $ ESOP ABC Manufacturing Company Step 1 $121,328 Co. makes contribution to ESOP (fully deductible) $
ATICG © 2002ATI Capital Group, Inc.7 Benefits to the Selling Shareholder Tax Deferral on 100% of the proceeds from the sale of stock to the ESOP, under Sec of the Internal Revenue Code! If the transaction is structured properly, capital gains tax may be permanently deferred!! NO CAPITAL GAINS TAX ON THE SALE OF YOUR STOCK TO AN ESOP – EVER!
ATICG © 2002ATI Capital Group, Inc.8 Powerful USE #2: Purchase of Capital Goods Lender Corporation ESOP Capital Goods 1 $ Loan 2 Stock The Basic Transaction Collateral Capital Goods Purchased With Pre-Tax Dollars = INCREASED CASH FLOW $ Cash Cap. Goods CAUTION: Dilution!!
ATICG © 2002ATI Capital Group, Inc.9 Benefits to the Corporation 100% deductibility of PRINCIPAL and interest on ESOP loan to buy capital goods. In addition to above deduction, can write-off capital goods a second time by means of DEPRECIATION. Increased cash flow due to deductibility of principal on loan. Collateral for loan created by acquiring the capital goods. Preferred terms on ESOP loan to acquire capital goods. Capital Goods Acquired for $0.66 dollars (PT), compared to $1.52 dollars (AT).
ATICG © 2002ATI Capital Group, Inc.10 Powerful USE #3: Purchase of a Target Company Lender Corporation ESOP Target Company 1 $ Loan 2 Stock The Basic Transaction Collateral Target Company Purchased With Pre-Tax Dollars = INCREASED RETURN ON INV. $ Cash Ownership CAUTION: Dilution!!
ATICG © 2002ATI Capital Group, Inc.11 Benefits to the Corporation 100% deductibility of PRINCIPAL and interest on ESOP loan to buy Target Company. Increased cash flow due to deductibility of principal on loan. Collateral for loan created by acquiring the Target Company. Preferred terms on ESOP loan to acquire Target Company. Target Company Acquired for $0.66 dollars (PT), compared to $1.52 dollars (AT).
ESOPs For ‘S’ Corporations A New Opportunity For Tax Planning
ATICG © 2002ATI Capital Group, Inc.13 New Legislation New Opportunities UNDER THE TAXPAYERS RELIEF ACT OF 1997 (effective January 1, 1998) UBIT No longer imposed ‘S’ CORPORATIONS CAN NOW UTILIZE ESOPs
ATICG © 2002ATI Capital Group, Inc.14 Tax Consequences Assumptions: S Corp 50% owned by ESOP and 50% owned by individuals who pay tax at a 39.6% MTR C Corp pays no dividends and pays tax at a 34% MRT Both corporations earn $1M taxable income Earnings net of tax left in company
ATICG © 2002ATI Capital Group, Inc.15 Tax Consequences Assumptions: S Corp 100% owned by ESOP and 0% owned by individuals who pay tax at a 39.6% MTR C Corp pays no dividends and pays tax at a 34% MRT Both corporations earn $1M taxable income Earnings net of tax left in company
ATICG © 2002ATI Capital Group, Inc.16 The Power & The Reality of ‘S’ Corporation ESOPs You can have a “For Profit” corporation that is “NOT” subject to Federal Income Tax on any level!!
ATICG © 2002ATI Capital Group, Inc.17 What Are the Differences?? ‘C’ Corp. ESOPs Seller can take advantage of Sec 25% of qualified payroll is deductible if leveraged; 15% if not leveraged Earnings of Corp. are fully taxable ‘S’ Corp. ESOPs Seller cannot take advantage of Sec 25% of qualified payroll is deductible Earnings of Corp. are not subject to Federal Income Tax, to extent company is owned by ESOP
ATICG © 2002ATI Capital Group, Inc.18 What Are the Differences?? ‘C’ Corp. ESOPs Seller, family of Seller, & 25% S/H are excluded from ESOP Second class of stock allowed in ESOP, if it is the highest class of stock or convertible into the highest class of stock Valuation reflects tax- affecting ‘S’ Corp. ESOPs Extensive exclusions for family members and 10% or greater S/Hs under anti-abuse rules Second class of stock not allowed (can have common non-voting) Valuation often does not reflect tax-affecting
ATICG © 2002ATI Capital Group, Inc.19 Okay, But Who’s in Control?? Because if it’s not me, I don’t want any part of this ESOP concept!! All I want is to control my business now and after I die.
ATICG © 2002ATI Capital Group, Inc.20 The Structure of Control A.If an ESOP holds a minority interest in its Sponsoring Company’s Securities, control has not changed. No further action is necessary. B.If an ESOP holds a controlling interest in its Sponsoring Company’s Securities, control has technically passed & further action is necessary.
ATICG © 2002ATI Capital Group, Inc.21 Methods of Maintaining Control Maintaining Absolute Voting Control Don’t Do Any Planning & Don’t Sell Any Portion of Your Stock Holdings Own 51% Voting Control Outside of ESOP
ATICG © 2002ATI Capital Group, Inc.22 Methods of Maintaining Control Maintaining Function Voting Control Be Appointed Trustee of ESOP – (temporary) Become Chairman of ESOP Committee That Directs the Trustee Obtain Lifetime Appointment as Chairman of the Board of Directors Obtain Lifetime Appointment as CEO
ATICG © 2002ATI Capital Group, Inc.23 The Flow of Control Unallocated ESOP Shares Allocated Shares Directives Participants ESOP Committee Vote VoteVote Trustee Chairperson of Committee controls Block could be controlling interest or minority interest. Minority shareholders - merger - reorganization - sale of assets - acquisition - liquidation Company BOD Appoints: ESOP Committee Trustee of Plan Shares actually in Partici- pant’s account. Shares not in Participant’s account. Control is a matter of proper structuring!
ATICG © 2002ATI Capital Group, Inc.24 The Emotional Issue of Control ASSIGNMENT: Defend financially (not emotionally) why anyone would insist on owning 100% of a company, if he/she controls the vote.
ATICG © 2002ATI Capital Group, Inc.25 The Alliance Project Manager/Consultant CPA Attorney for ESOP Attorney for Corporation Valuation Professional Insurance Professional Trustee Plan Administrator Lender Investment Advisor We Provide Your One-Stop-Shop ESOP Alliance Your Strategic Partner
ATICG © 2002ATI Capital Group, Inc.26 Contact Information Sam G. Torolopoulos, CPA-ABV 222 West Las Colinas Blvd., Ste E, Irving, TX , fax Web Sites:
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