“My client has an employee stock ownership plan (ESOP). How does he value the stock within the plan if it is not traded on a securities market?”
ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with a financial advisor from Wisconsin is representative of a common inquiry related to valuing stock of the sponsoring employer in qualified retirement plans.
Highlights of the Discussion
For employer securities that are not readily tradable on an established securities market, the IRS requires the shares be valued by an independent appraiser [IRC 401(a)(28)(C)]. Valuation by an independent appraiser is not required in the case of employer securities that are readily tradable on an established securities market.
There are a number of factors to consider when determining the value of an asset within a qualified retirement plan. In its examination guidelines, the IRS supports the use of Revenue Ruling 59-60, which relates to valuing assets for estate tax and gift tax purposes, for valuing assets in qualified retirement plans as well.
In valuing the stock of closely held corporations or the stock of corporations where market quotations are not available, all available financial data, as well as all relevant factors affecting the fair market value must be considered. For example, some factors to consider include the following:
- Nature and history of the business issuing the security;
- General economic outlook and the outlook for the specific industry;
- Book value of the securities and the financial condition of the business;
- Company’s earning capacity;
- Company’s dividend paying capacity;
- Goodwill value; and
- Recent stock sales.
The list of factors to consider in Rev. Rul. 59–60 is not an exclusive list for valuing closely-held employer securities. It may be necessary to consider other factors when appropriate. Also, not all of the listed factors will be relevant to all companies and transactions. The IRS’ examination guidelines note that the independent appraisal will not, in and of itself, be a good faith determination of value unless all relevant factors are considered.
IRS examiners will look at Form 5500 (Schedule R, line 12) to the question: Does the ESOP hold any stock that is not readily tradable on an established securities market? If the answer is yes, examiners are directed to determine if the securities were valued that year and by whom in order to confirm it was done by an independent, third-party auditor.
An ESOP that holds employer securities that are not readily tradable on an established securities market must follow specific guidelines for annual asset valuation. The valuation requires the use of an independent auditor who observes the requirements of Rev. Rul. 59-60.