Category: Advanced Tax Planning

ESOP – Employee Stock Ownership Plan

An ESOP is a qualified retirement plan funded primarily with the stock of that business.  As an enticement for business owners to “share the wealth” with their employees, Congress has provided ESOPs with 3 key tax advantages.

ESOP Tax Advantages

  1. Under certain circumstances, the business owner can sell the stock and defer the tax on the gain.
  2. If the ESOP was established with funds from a third party financial institution, both the interest and principal payment s may be deductible.
  3. If the company is an S-Corp, income generated by the ESOP may be tax deferred

ESOP Versus  401(k)

The main difference is that a 401(k) is generally funded with the employees’ own pre-tax contributions and potentially an employer match.  The ESOP is funded 100% with employer/business contributions.  Much like a 401(k) there is no guarantee the company and the Plan will be a good investment, but because there is no cash outlay by the employee, there is seemingly little downside for the employees.  The major ESOP downside may be failed expectations and delusions of grandeur that too often result in employees suing the company, the attorneys, the valuation experts, the trustees, and anyone else seemingly involved with the ESOP.  The expectation of litigation is one of the reasons ESOPs are complex and expensive.

Because both are qualified plans, both an ESOP and 401(k) can be in place at the same time, assuming the company has the financial wherewithal to do it.  The main issue with the ESOP is that its investment depends on the performance of a single company in a single industry.  So if the company does poorly after the owners get their cash out, litigation against all parties can be expected.

ESOP Costs – It’s Expensive

An ESOP will likely cost $150,000 and could easily cost $250,000 up front, just to initially establish.  Annual cost will continue throughout the life of the ESOP.  You can expect continuing tax compliance,  ERISA compliance, costs for extra tax returns, and annual business valuations, etc.  An ESOP is not for an owner who just wants a simple exit. For an ESOP to be cost effective, you need to have a company that has at least 40 employees and annual sales in excess of $5 million.

Is the Owner ready to Open the Books

At the very least, the business owners will have to allow employees access to the annual valuation of the company.  As news owners, with perceived “chips in the game”, most employees will demand greater access to company financials throughout the year.  Accordingly, time, effort, and money will need to be spent teaching employees to be more financially literate.

Many business owners have become accustomed to making decisions by themself and don’t like sharing information with employees.  ESOPs are generally not a good fit in this atmosphere.  Business owners who like the idea of getting employees involved in decision making and are willing to get more people involved in the decision making process, should explore the ESOP as an exit strategy.

Does the Business Expect Growth?

Through an ESOP, employees will become beneficiaries of the stock value of the company.  If the company isn’t growing and doesn’t increase in value, the ESOP will become a negative in the eyes of the employees and potentially doom the company.   Accordingly, ESOPs should not be undertaking merely for financial or tax benefits.  The makeup and drive of the employees, the business, the industry, and the total chemistry and potential synergies must be considered.  The company must have a well trained and experienced management team in place that can lead the company to continued and sustained profitability.  The company should also have the training in place to attract and create the next generation of management.

ESOP – Not a Quick Exit Strategy

If you are in a hurry, the ESOP strategy is not for you.  The ESOP takes many years, sometimes more than 20 years to complete the sale of the company to the ESOP.  Time should be available to unwind the ESOP if it’s not working out.  You must have time, patience, energy, and the money to make the Plan work.

Additional Issues – Talking Points

  • ESOPs have repurchase obligations.  Employees can require the ESOP to repurchase their stock when they leave the company.  This is out of control of the company management and may create cash flow issues and obligate the company to hamper the balance sheet and create and carry funds for current and future repurchase obligations.
  • ESOPs are difficult to unwind.  The unique structure of the ESOP makes it incredibly complex and expensive to unwind or sell a company with an ESOP.
  • Raising equity capital for an ESOP company may also be very problematic.

So What’s the Best Answer

The best answer is get an objective and thorough analysis and education of all succession, exit, business, and tax planning options that are available to you, the business owner.  Promoters are quick to sell the positives and business owners can become fascinated with the theory of an ESOP without fully understanding the complexities, costs, and risks.

Your Business Exit Strategy

You should only implement your Exit Strategy after thoroughly and objectively educating yourself on all business, tax, and legal options for converting business wealth into personal wealth.  ESOP should be a part of the discussion that includes all exit strategies -qualified and nonqualified retirement plans, management buyouts, defined benefit plans, sale to third party buyer, sale to family, or any other tax and business friendly method of exiting your business.  Just remember, whatever method you choose, the IRS will be an interested spectator.

Call us for help or with questions!

The Business Wealth Preservation Group is a professional services firm dedicated to providing superior individualized and custom service to individuals and their businesses in the areas of asset protection, tax planning, exit strategies, and wealth building. Simply put – we want to educate you on all relevant opportunities to put more dollars into your pocket, your business and your future.

We focus on leading edge, sophisticated, and safe business strategies that will help business owners structure, operate and maintain their business to take advantage of business and tax laws rather than being encumbered by them. We partner with the business, the accountant, and the attorney to ensure the business owners are capturing all available benefits that align with their business and personal goals.

www.BusinessWealthPreservation.com
Call Us Toll Free: (888) 938-2975 (888-WE-TAX PLAN)
Email:
tfoster@wetaxplan.com

The Complexities Associated with the Purchase of a Corporate Aircraft

In response to your request for our input on the purchase or use of a corporate jet our opinion follows.

The purchase of an aircraft is perhaps the most complex transaction that business owners can undertake.  Unlike any other asset, not only do the ownership, use, and location options need to consider the legal and tax ramifications, but also the rules, restrictions, and implications of the Federal Aviation Administration (FAA).   This is NOT simply a matter of what type of entity should own the aircraft and in which state should that entity be established.  The manner in which the aircraft is funded, owned, and operated can determine which FAA regulations apply – Commercial Aviation Rules versus General Aviation Rules.

The main issue with private corporate ownership is that if you fall under the commercial aviation rules you are treated just like United, Delta, and American and can be subject to six and seven figure fines that may be assessed retroactively on a per flight basis.  The complexities associated with corporate aircraft ownership has created attorneys know as aviation attorneys that dedicate their legal practices to these issues.

The Complexities of the Governing Rules – FARs

The complex FAA rules know as Federal Aviation Regulations (FARs) must be analyzed carefully when purchasing and operating an aircraft.  Particularly, FARs Part 91 regulates General Aviation Rules that apply to business and personal use of aircraft and are generally much less restrictive than those found in FARs Part 135 – Commercial Aviation Rules, which apply to aircraft used commercially but also those classified as used “for hire.”

So on the surface at least it would seem that to avoid the complexities and cost of complying with the Commercial Aviation Rules, the ownership and operational structure should be set up to avoid the “for hire” usage.  Sounds simple, but the IRS regulations complicate and seem to be at odds with this strategy.

IRS Complexities

The FARs and IRS Code Sections 61 and 274 create a tangled and at times conflicting set of rules for a business that wants to limit liability and minimize taxes.   To avoid or limit income restrictions and adverse tax consequences including the disallowance of operating deductions, the IRS has advised businesses to have their owners and employees reimburse the company for the value of the aircrafts use on non-business flights.  Although this alleviates tax issues, it unfortunately puts the business in the “for hire” provisions (even if done at cost, a lack of profit doesn’t matter) and therefore classification as a commercial carrier.

Other tax considerations that are beyond the scope of this initial analysis include sales and use tax on the purchase and use of the aircraft, depreciation rules that vary by the use of the aircraft, and Section 1031 rules that provide a tax friendly way to “trade-up” to your next aircraft.  Note: Sales tax rules apply generally based on where you accept delivery of the aircraft.  Use taxes still would apply in other states.   Sales tax issues should be considered before the purchase of the aircraft.

Insurance Issues

The FARs also creates potential issues regarding insurance.  Given the complexities of the rules, insurance coverage that was purchased as a non-commercial operation that unwittingly operates under FAA commercial status could be flying the plane without insurance for the plane, passengers, or crew.  This could result in potentially large legal liability issues to the business entity and owners.  A careful examination of insurance coverage and usage is critical.

The Single Asset Issue – This is Important

Under the FARs, an entity whose only asset is an aircraft is deemed to be in the business of providing air transportation service for compensation, and as such, must operate under the stricter commercial standards of Part 135.  Undoubtedly, the FARs create complexities unlike the more traditional tax and legal asset planning strategies.

So now that you better understand the complexities, here are a few of the options for ownership:

Ownership Option 1 – Exclusive Ownership

A new LLC is formed “JetCo” to purchase and own the aircraft.  However, to avoid the Commercial Aviation Rules, JetCo should not operate the aircraft.  Instead JetCo should “dry lease” the aircraft to the current business entity.  A “dry lease” is the lease of an airplane without a captain and crew.  The current business entity, the lessee, provides the captain and crew.  This structure should allow you to operate under the more desirable General Aviation Rules but care must be taken to ensure that the lease payments do not exceed the permissible amounts.   It may also be prudent to carry additional liability insurance to cover operator negligence or error, given that the business entity provides the captain and crew.  The company must employ the pilot and crew as employees or independent contractors.  This should be explored in greater detail.  The single asset issue must also be considered.

And of course, complexities are also created with any guest passengers.

Ownership Option 2 – Purchase and Enrollment in a Charter Service

A new LLC is formed “JetCo” to purchase and own the aircraft.  However, the aircraft is then enrolled in a charter service.  Under this arrangement, JetCo owns and “dry leases” the aircraft to the current business entity as well as the commercial charter service.  The charter service uses the aircraft to transport third parties.  This option helps to defray ownership costs, but the aircraft will not be available 24/7 and may not be available for last minute or unplanned trips.

FAA Regulations that pertain to charter services must also be analyzed and considered before committing to this option.

Option 3 – Fractional Ownership

FAA Rules permit multiple individuals or entities to jointly own a corporate aircraft.  Fractional ownership is essentially equivalent to an “aircraft timeshare.”    This option is generally less complex and less expensive than exclusive ownership.   The fractional sponsor generally deals with regulatory compliance, aircraft management and scheduling, and liability insurance.

Option 4 – Jet Cards or Air Taxis

A company can pay a fee in advance and have the ability to fly a set number of hours per year.  Jet card programs do not provide ownership benefits, but do avoid the complexities and capital investments of private ownership.

Call us for help or with questions!

The Business Wealth Preservation Group is a professional services firm dedicated to providing superior individualized and custom service to individuals and their businesses in the areas of asset protection, tax planning, exit strategies, and wealth building. Simply put – we want to educate you on all relevant opportunities to put more dollars into your pocket, your business and your future.

We focus on leading edge, sophisticated, and safe business strategies that will help business owners structure, operate and maintain their business to take advantage of business and tax laws rather than being encumbered by them. We partner with the business, the accountant, and the attorney to ensure the business owners are capturing all available benefits that align with their business and personal goals.

www.BusinessWealthPreservation.com
Call Us Toll Free: (888) 938-2975 (888-WE-TAX PLAN)
Email: tfoster@wetaxplan.com

The forgoing should not be construed as legal advice, and should merely be used for preliminary discussions.  You should consult with an aviation attorney before taking any action.

CIRCULAR 230 DISCLOSURE:  In compliance with the requirements imposed by the IRS pursuant to Circular 230, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.


Copyright 2010 The Business Wealth Preservation Group, LLC.