ESOP Case Studies

How ESOP owned companies miss opportunities!

How many ESOP businesses does your accounting firm support? RPB and AmbroseAdvisors support over 100 ESOP clients. We have provided three short studies that focus on:

  • Immediate financial savings
  • An error that led to a significant tax to be paid
  • Communication issues that created exposure

Study #1. The CPA and Recordkeeping Firms Were Asleep!

$340,000 immediate savings.

SITUATION. Our CPA firm and ESOP recordkeeping firm were invited to meet with an ESOP owned manufacturing company. They initially were most interested in our record keeping services. As the meeting progressed we learned they were a C-corporation with a 12/31 year-end and were 85% owned by the ESOP. We also learned they were having a very profitable year and were expecting to owe over $400,000 in income taxes.

SUGGESTION. Because the company was already 85% ESOP owned, we explained the tax benefits of ESOP owned S-corporations and suggested making an S election immediately. As you may know, C corporations pay corporate level taxes on net income, while S corporations do not – the shareholders of S corporations pay taxes on the income earned in the corporation. Accordingly, when an ESOP is a shareholder of an S corporation, no income taxes are paid by the ESOP – it is a tax exempt trust. Management was aware of the S-corporation benefits, but had not been advised by their CPA or record keeper when to consider making the election. After our meeting, they asked their CPA and were told it was too late to make the election for the current year. We explained the IRS revenue procedures that allow for late S-elections and our experience with successful late S-elections.

RESULT. After a detailed review of tax returns for potential built-in-gains and management discussions regarding future business plans and ESOP strategy, we filed the late S-election which was accepted by the IRS. This was a win for everyone and the company achieved a substantial tax savings of over $340,000 in the first year alone.

MORAL OF THE STORY. Very few CPA firms serve any ESOP owned companies and the few firms that do often have only one or two ESOP clients. An ESOP company needs an ESOP knowledgeable CPA firm in order to get all the benefits of ESOP ownership.


Study #2. Accounting Method Change Created Tax on $12,700,000

Significant tax losses due to lack of planning.

SITUATION. A successful construction company reported taxable income on a cash basis and was already an S corporation. The company became 30% ESOP owned in 2005. The company was served by a national CPA firm and a large, reputable east coast ESOP record keeping firm. In 2010, the CPA firm determined that a cash-to-accrual accounting method change was required and prepared the appropriate tax forms. The non-ESOP shareholders received S corporation distributions after the ESOP transaction, but neither the CPA nor the record keeper advised them of the requirement to make proportional distributions to the ESOP. Both the CPA and the record keeper were in a position to identify this and advise their client. This created the potential for significant plan penalties or even a prohibited transaction.

By the time RPB was invited to meet with the company in 2011, the company was experiencing significant operating losses on an accrual basis due to the recession and yet having to report substantial taxable income to the shareholders because of the accounting method change. There was no cash available to pay income taxes and the company still had over $10,000,000 of taxable income to report over the remaining 3 years.

SUGGESTION. We thoroughly analyzed this complex circumstance considering both shareholder and company best interests and recommended a transaction to have the company become 100% ESOP owned. This recommendation helped the company avoid a terminal tax problem and bought time for operational recovery.

RESULT. As of 2013 the company has returned to profitability. Our involvement was a win-win for the company, the selling shareholders and the ESOP participants.

MORAL OF THE STORY. The incumbent ESOP service providers were not coordinating and did not take the time to really “know” their client. The size of the CPA firm and record keeper does not ensure they will provide a better solution. Our annual ESOP advisor meeting that we recommend each ESOP client of ours conduct would have identified the impending issues well in advance of a crisis.


Study #3. Significant Exposure Due to Errors

Lack of coordination between the CPA and the record keeper.

SITUATION. The shareholders of a successful hardware distribution company sold 100% of their common stock to a newly formed ESOP. This was a complex transaction which included both bank and seller financing, stock warrants and a sophisticated management incentive plan. The day of the transaction was the last contact with the ESOP attorney and the valuation firm was good enough to recommend a record keeping firm. The incumbent CPA firm was never involved in the transaction and had minimal ESOP experience.

The company president became very frustrated when he was made aware of numerous ESOP contribution calculation errors and the need for amended tax returns and restated financial statements. He expected his ESOP service providers to coordinate with each other and confirm the correctness of the various ESOP accounting and tax calculations. He also hoped the ESOP service providers would cooperate with each other to complete timely year end reporting so the ESOP participants could have their account statements in May or June, not October or November. Unfortunately, this unhappy situation is more the norm than the exception.

SUGGESTION. Our firms, RPB CPAs and our ESOP record keeping firm, AmbroseAdvisors, were introduced to the company by the valuation firm. We explained our philosophy of quarterbacking all year end reporting and the synergy of the combined CPA and recordkeeping function.

RESULT. We provided a year end reporting schedule with target dates for all the ESOP service providers and were successful in cutting months off the previous year reporting cycle in the very first year of our engagement. We were also able to make a very impactful presentation to the ESOP participants to help them better understand the ESOP and their account statements.

MORAL OF THE STORY. The CPA should be the most responsible professional with respect to financial statement and tax reporting, tax advising and general consulting. The CPA should know you and your company better than any other service provider and be driving the ESOP reporting process and identifying emerging ESOP consulting needs. CPA firms with little or no ESOP experience are just not capable of performing in this role. Those firms might be able to file returns, but a non-ESOP experienced accounting firm has no idea of the numerous tax, reporting and planning strategies involved in an ESOP entity.