409A Extension/Rangel Proposal/ESOPs and Succession Planning/CEO Stock Options

The Employee Ownership Update for October 29, 2007 is online and discusses the following:

409A Deferred Compensation Compliance Rules Delayed Until 2009

As we discussed in Additional Section 409A Transition Relief, the IRS released IRS Notice 2007-86 - Notice of Additional 2008 Transition Relief under Section 409A, which supersedes Notice 2007-78 - 2008 Transition Relief and Additional Guidance on the Application of § 409A to Nonqualified Deferred Compensation Plans, which we discussed in 409A Extended Documentation Deadline. While the Notice generally extends the compliance date to December 31, 2008, the Update stresses the importance of not ignoring the law until then:

"This does not mean companies can ignore the law until then. Companies will be considered compliant only if they operate their deferred compensation plans in accordance with the law and with regulations published under it through 2008. So any deferred compensation issued after the Code section's 2005 effective date will have to meet the proposed or final rules that were in effect when the awards were issued, while any deferred awards issued before that date are given through the end of 2008 to be brought into compliance with the final regulations."

The Pension Protection Act Blog discusses the deferred compensation plans rules in Compliance with the Final 409A Regs Extended Again and Savings Clause Now Disregarded in Deferred Comp Plans.

Finally, the Update mentions IRS Notice 2007-89 - Reporting and Wage Withholding Under Internal Revenue Code § 409A:

"This notice provides guidance to employers and payers on their reporting and wage withholding requirements for calendar year 2007 with respect to amounts includible in gross income under § 409A of the Internal Revenue Code. This notice also provides guidance to employers and payers on their reporting requirements with respect to all deferrals of compensation under § 409A of the Internal Revenue Code for 2007. This notice does not affect the application of § 3121(v)(2) or an employer's reporting obligations under § 31.3121(v)(2)-1 of the Employment Tax Regulations. In addition, this notice provides guidance to service providers on their income tax reporting and tax payment requirements with respect to amounts includible in gross income under § 409A for 2007. Generally, these requirements for 2007 reflect an extension to 2007 tax years of the guidance provided in Notice 2006-100 applicable to 2005 and 2006 tax years."

Rangel Proposal Would Tax Synthetic Equity in S Corporation ESOPs

The Update summarizes the Rangel tax proposal as follows:

"Congressman Charles Rangel (D-NY) has proposed to tax synthetic equity at exercise in S corporation ESOPs in a way that would reflect their share of the foregone corporate taxes attributable to the ESOP as income. Interest would be charged on any resulting underpayment for the period. In effect, the bill would treat holders of synthetic equity as if they actually owned an equivalent value of the S corporation's stock and would be subject to taxation on corporate profits for their pro-rata share of net income during that period. The law would apply only to grants issued after enactment."

The Update also discusses the how the Tribune Company sparked this proposal and how the law would only apply to grants issued after enactment.

For more information on the Rangel tax proposal, please see the following posts:

Rangel's Corporate Tax Proposal

Update on Rangel's Corporate Tax Proposal

Text Of Rangel's Tax Proposal

PricewaterhouseCoopers Survey Shows 19% of Fast-Growing Companies Plan ESOPs as Business Transition Strategy

The Update discusses results from a 2006 Trendsetters Barometer Survey. What is the Trendsetter Barometer Survey?

"Each quarter, PricewaterhouseCoopers' "Trendsetter Barometer" interviews CEOs of America's fastest-growing private companies.

PricewaterhouseCoopers' "Trendsetter Barometer" is a quarterly telephone survey of more than 400 CEOs of businesses recognized for their sustained, rapid growth. These business leaders and their pace-setting companies have the cachet of success. They are truly "companies with extraordinary potential." They average $33 million in annual revenues, have 216 employees, and an ongoing annual growth rate of about 25 percent. Half these CEOs say their companies are recognized as high tech businesses."

The report of the above-mentioned survey is titled: "Few Fast-Growth CEOs Plan For The Transition Of Their Business Family-Business Owners Lag Behind; Less Than 50% Address Succession In Estate Plan." As the title suggests, many CEOs are not planning for their succession:

"Most CEOs of fast-growing private companies ultimately expect to be acquired by another company. However, they place relatively low priority on planning for this significant event, or their own succession. This is even more the case for businesses that are family-owned. For these companies, only 47 percent of CEOs have an estate plan that addresses the disposition of the business, and only 22 percent have revised it within the last two to five years, PricewaterhouseCoopers finds."

The report discusses the following points:

• "Transition planning barely hits the radar screen"
  
• "The majority expect to be bought"
  
• "Family plays a role"
  
• "Uncoordinated planning for family-owned business and personal needs"
  
• "Few have an independent board that can advise on transition"

Here are the results of how they plan to exit:

"When asked about eventual transition out of their business, many of these "Trendsetter" CEOs have more than one likely exit plan (an average of 1.5) in mind:

• 62 percent expect sale to another company;
  
• 29 percent a management buyout;
  
• 22 percent a sale or transition to next-generation family members;
  
• 19 percent an ESOP (employee stock ownership plan); and
  
• 14 percent an IPO"

The Update compared the results to the 22.3% of the companies listed on the Inc. 5000 Index that state that Selling to an ESOP is a Likely Strategy for Transferring Ownership. The Update also notes that half of the companies consider themselves as high-tech and notes that this could be an important change in how ESOPs are used:

"Given that ESOPs tend to be used for business transition more in mature companies than fast growing newer companies, the number of companies choosing ESOPs represents a potentially important change in how these plans will be used in the future."

Large Option Grants to CEOs Appear to Hurt Investors

The Update discusses Swinging for the Fences: The Effects of CEO Stock Options on Company Risk-Taking and Performance, a study that appears in the October/November issue of the Academy of Management Journal:

"The findings support a critique made by many observers (including the NCEO) of outsized equity grants to CEOs: They encourage excessive risk taking. The higher the volatility of stock returns, the more valuable options are (because they only need be exercised when in the money). Coupled with the fact that most CEOs stay in their jobs five years or less, there is tremendous incentive to take large risks."