ESOP Can Be a “Win-Win-Win” Situation for Closely Held Banks

David M. Graf is a partner at Friday Eldredge & Clark, LLP. Dave concentrates his practice on the design, implementation, maintenance and administration of tax-qualified retirement plans (including defined benefit pension plans, profit sharing plans, 401(k) plans and ESOPs), nonqualified deferred compensation plans, and welfare benefit plans for financial institutions, regular business organizations, professional corporations, and governmental and non-profit organizations. ABOUT THE AUTHOR

An employee stock ownership plan (“ESOP”) is a powerful and effective tool that can be used by a closely held bank to address many different issues within the bank. An ESOP when used in the right circumstances can provide the following advantages: 1. Shareholder Succession. An ESOP can be used as a tool for shareholder succession planning and liquidity. One of the benefits under such a scenario is being able to utilize the ESOP as part of a “Section 1042 transaction.” A 1042 transaction allows a selling shareholder (or group of selling shareholders) to completely defer (and possibly eliminate) income taxes on the sale of bank stock to the ESOP. For Section 1042 treatment to apply, the bank must among other requirements be a “C-Corporation” and the ESOP after the sale must own 30 percent or more of the bank’s Stock. 2. Employee Benefit. Banks often times utilize an ESOP as part of an employee’s overall benefits package. Typically, the ESOP supplements an existing retirement plan such as a 401(k) plan to provide a generous retirement plan package for employees. Employees own shares of stock in the bank as held through the ESOP which gives them an “ownership interest” and sense of pride in the bank. 3. Tax Benefits to the Bank. Generally, an ESOP is structured as a “leveraged

8 The Arkansas Banker | June 2017 transaction” in which a loan is obtained by the ESOP (and guaranteed by the bank) to purchase bank stock. To pay off the loan, the bank makes payments (typically on an annual basis) to the ESOP to pay down the loan of which said payments are tax deductible at the corporate level. Ordinarily payments of principal on a note by a corporation are not tax deductible. Said tax deduction would not be available if a loan is utilized as to the sale of the stock with a nonESOP buyer or as part of a stand-alone corporate redemption. There are also additional tax benefits at the corporate level if the bank is an S corporation. Banks that are good ESOP candidates generally have: 1. A solid earnings performance. 2. Stable cash flow. 3. Good senior management. 4. Payroll sufficient to support the contributions to the ESOP as to a leveraged transaction. To see if an ESOP is right for your bank, a feasibility study should be performed to confirm that the bank is in fact a good ESOP candidate. For more information on ESOPs or to discuss how an ESOP might be beneficial for your bank, please contact Dave Graf at Friday, Eldredge & Clark, LLP.

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