Owners of waste management companies share many of the same cash and tax challenges as all business owners. The most recent federal tax legislation, the Economic Growth and tax Revenue tax reconciliation Act of 2001 (EGTRRA) positively impacts some very useful planning tools. This article will discuss two of the plans. The Employee Stock ownership Plan (ESOP) is most appropriate for companies with 25 to 500 employees. The IRC Sec. 412 (i) pension plan is a superb tool for companies with ten (10) or less employees. When appropriate to do so, both plans can be used by the same company by establishing “satellite entities". The specifics of this hybrid design are beyond the scope of this article and can be discussed on an individual basis. First we look at the ESOP.
The reasons why there is an estimated 1 trillion dollars ($1,000,000,000,000) involved in ESOP's are:
- A business owner can cash out or phase out of his business- TAX FREE.
- Provides “golden handcuffs" for key employees.
- The company becomes more efficient and profitable because owners always work harder than employees.
About three years ago a client whose business was the recycling of paper products decided it was time for a succession plan. He had 25 employees and while he had received some outside offers to purchase his business his objective was to transfer ownership to the people who contributed to his success - his employees. As is usually the case, his employees collectively did not have the capital necessary to buy the business from him.
Furthermore, I had to apprise my client that if the owner of a closely held company redeems less than 100% of his company stock it would be problematic to avoid ordinary income tax treatment rather than capital gains treatment, potentially doubling of the tax burden. An ESOP plan was the solution. The IRS provides an unequaled tax advantage to business owners encouraging them to sponsor these statutory strategic plans. Essentially, the tax relief provided to business owners results in the IRS paying for a significant portion of the companies purchase price with the employee not required to make any personal out of pocket contributions.
Additionally, when business owners sell either some or all of the stock in their company to their ESOP they can easily avoid all income and capital gain tax liability. The client also indicated that he had four key employees which he considered to be very important to the future success of the corporation. Again, the ESOP provided the solution. The stock which is held in the ESOP trust is allocated to employees based upon their compensation. Typically the key employees are members of the highest paid group and therefore they are going to receive the lion's share of any cash and or stock that is being held in the ESOP.
In this situation the employer wanted to really put “golden handcuffs" on these key employees and we structured a separate plan to be used in addition with the ESOP plan wherein only these four key employees were included. If the employee of an ESOP company will simply provide 100% of his best effort to make the company as efficient and profitable as is possible than everyone on the team wins. Additionally, in exactly the same way as publicly held companies, the value of closely held companies is primarily a function of its earnings. When all employees are motivated as a team toward a common goal the positive earnings result can be nothing less than dramatic. It is also worth noting that business owners enjoy the satisfaction of achieving success in the capitalistic adventure and I often wonder if this isn't equally as important as the financial rewards. By making the employees think like owners/capitalists common objectives are pointed in the same direction.
Without much ado it is self evident that owners always work harder than employees. Statistics continually bare this out. ESOP companies are from 16% to 60% more profitable than their counterparts. During slow economic periods ESOP companies are always better able to weather the difficulties because whenever everyone has a vested interest, the creative and imaginative energy which owners can bring to bare on the situation always provides the incremental advantage.
Now a solution for a company with less than twenty five (25) employees. Two years ago I met with a client who was involved in brokering waste management services. With only four employees this business owner was showing excellent profit and was tired of giving half of it to Uncle Sam. My recommendation was a type of pension plan particularly suited for companies with few employees with the owner(s) needing maximum tax relief. This IRC Sec 1412(i) can provide this group of business owners an opportunity to make significant tax deductible contributions to plans where the lions share of the proceeds will be allocated to the owners accounts.
While the techniques used do not lend themselves to mass marketing or media ad campaigns by financial service companies or to self study, professionals who are well versed on this type of program can help business owners enjoy some very rich in cash tax advantages by proper structuring. Members of the waste management services community should be made aware that the solutions are available to accomplish the objectives of various size businesses. I hope that I have been able to stimulate the reader to be proactive toward investigating the alternatives to assist them in best accomplishing their objectives for themselves and their businesses.
Frank Amato is Managing Member of the Arizona ESOP Group LLC and can be reached at 480-222-0199 or 480 227 3064, . There is never any obligation and all discussions are confidential.
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