This article appeared in the National Center for Employee Ownership (NCEO) Employee Ownership Report, September-October 2004

By Cathy Ivancic, Workplace Development, Inc.

Moving from being a C corporation to an S corporation is complicated enough – but then there is the question of whether you should communicate the change to participants in an ESOP company. After all, the change is both monumental in its potential and immediately insignificant for most participants.

There is no requirement to communicate this change in tax status. A few sentences in the company news letter or a brief letter with a new Summary Plan Description (SPD) may suffice. Some companies have committed to provide a deeper explanation of the change. Below are a few of their compelling reasons for taking on this challenge.

Part of a commitment to sharing information

Changing to S-corporation status is inevitably part of a company’s business strategy so companies that share regular strategic information find that they must explain the change. “It’s their company,” explains Ann Allard, VP for Human Resources for W. M. Barr & Company in Memphis, TN. “We make it a point to explain this kind of  change even if it is complex.” In the year that Barr changed to S-corporation status, company sent out a payroll stuffer and followed up with meetings for all employees on the topic.

In the year of the change to S corporation, Allied Mineral Products in Columbus, OH dedicated their small group employee owner meetings to the change. “We’ve talked quite a bit about planning for repurchase,” says Suzanne Tabor Deffet, company CFO. “It was important for people to know that this change was a part of our repurchase strategy.”

Observable changes to participant accounts

The change from C to S corporation can include changes to the plan provisions and participant accounts. When the change affects participant accounts, then the need for clear communication is increased. “We wanted everyone to know that they will see earnings going directly into their account,” notes Deffet when explaining earnings distributions inside the Allied Mineral Products ESOP.

Participants needed to get the whole picture of the changes at W. M. Barr & Company. IRS limits for S-corporation contribution levels resulted in a smaller number of shares allocated to individual accounts each year in this company. In addition, S-corporation status meant that Barr would no longer make distributions in stock. “Even though almost no one opted for the stock distribution, we wanted to be clear about all of the changes,” noted Allard.

Potential impact on business value

“In our case, participants needed to know that the potential long-term benefits of being a 100% ESOP S-corporation outweighed a possible short-term drop in value by taking on debt,” says Mark Sidell of Schuck & Sons Construction based in Glendale, AZ. The S-corporation change happened at the same time the company took on debt for a 100% ESOP transaction. This created an opportunity for company leaders to hold meetings to explain changes in the company and share a vision for the future of the business.

Communicating the potential impact on value without making promises is the key. “We communicated that the additional cash from tax savings could free up dollars for making acquisitions,” says Allard of Barr. “We explained that this was a competitive edge but not a guarantee.” In the year after the change in status, W. M. Barr & Company made an acquisition — which contributed significantly to the company’s performance in a difficult year.

“We had planned to make the change to Sub-S for some time,” Sidell notes. The timing was right to explain it at Schuck & Sons when employees would be interested in hearing about other changes in the business. The company answered questions in meetings at multiple locations and provided supplemental handouts in English and Spanish. “You have to stick with it and repeat the information over and over,” says Sidell about communicating about ESOP.

The benefits of a change in tax status can be invisible to employees. Despite this, many ESOP companies have found that participants – whether they are production employees, secretaries, construction workers, or engineers — genuinely want to know the impact on their account and can appreciate the potential impact the change will have on the future of the business.

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