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The ESOP alternative for CPA and accounting firms

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Private equity’s run through the ranks of the accounting professions showed no signs of slowing in 2024. But recently, employee stock ownership plans have emerged as an alternative succession strategy for middle-market firms. Long-viewed as a tax-advantaged transition tool for accountants’ business clients, CPAs are now embracing ESOPs for their own firms.

Why? Because leveraged ESOPs circumvent deferred compensation dilemmas. At most firms, new partners must pull in revenue and generate profits to gradually pay departing partners. Paradoxically, departing partners are generally among a firm’s biggest producers. As a result, a single ownership transfer period can last as long as 10 years and is often completed below fair market value.

ESOPs enable new accountants to earn equity without having to fund a deferred compensation arrangement and without having to pay out of pocket to buy-in. Instead, an employee ownership transaction can provide for a seamless, rolling transition of ownership. Partial ESOP transactions are common, enabling firms to sell targeted blocks of retiring partner stock to an employee trust. But CPA firms can only unlock the utility of an ESOP when they fully tap into the relative flexibility of these strategies.

Creating supplemental incentive opportunities

Anyone who has advised an employee-owned client knows that ESOPs are ERISA-based, non-discriminatory benefit plans. All eligible employees receive stock based on the same egalitarian formula. That makes sense for a typical business, where tangible assets are created and monetized at an organizational level. But an accounting firm’s value creation rests largely on the shoulders of its tenured partners. A standard employee ownership structure may not offer enough upside to entice or retain high-performing talent. 

Instead, CPA ESOPs are generally formed in tandem with nonqualified plans for firm leadership and top producers. These complementary structures are commonly used to create meaningful, discretionary phantom and synthetic equity opportunities.

Add-on benefits still need to be ERISA-compliant and negotiated as part of an ESOP formation. Nonetheless, supplemental plans are common fixtures at employee-owned professional service firms. These two-tiered strategies deliver short-term incentives to a firm’s established value creators, and long-term equity opportunities for all employees and future hires.

Normalizing EBITDA

Many broadly held accounting firms zero-out their net income in any given year. Meanwhile, ESOP valuations are often rooted in adjusted EBITDA multiples. To bridge this gap, firms often perform compensation scrapes, a common staple of private equity deal transactions. The resulting retained earnings will drive pre- and post-sale enterprise values.

Scrape calculations generally factor in a partner’s overall performance, productivity and tenure. A thoughtfully constructed scrape offers valuable trade-offs for impacted team members. Senior partners may take outsized reductions in their income to generate that excess retained earnings, with the expectation that they are near-term ESOP buyout targets. Junior partners can expect additional warrant or phantom stock grants that offer greater mid-to-long-term economic upside.

In addition to formalizing a firm’s valuation, EBITDA normalization and the resulting earnings retention creates a durable funding source for firm modernization and expansion. These investments are critical to continued competitiveness in an ever-consolidating industry. 

In a properly structured ESOP, these earnings are also tax-advantaged. Employee-owned firms can receive corporate income tax deductions equivalent to the value of stock sold to an employee trust. In other words, a $50 million ESOP sale should yield a firm $50 million in deductions. Furthermore, a 100% employee-owned accounting practice can effectively operate income tax-free in perpetuity.

Understanding the big picture

So, let’s study these lessons in a practical context. Consider a 300-member, $50 million revenue accounting firm with a broadly held ownership group. Thirty percent of the partner base are senior members of the firm, eyeing retirement within five years. An ESOP strategy is developed to acquire equity from these senior partners at a fair market valuation.

First, a firm-wide compensation scrape (weighted toward senior partners) is performed and yields $10 million in EBITDA. Based on prevailing industry multiples and adjustments, the firm’s assumed valuation is set at $100 million. So, there’s an expectation of a negotiated $30 million ESOP sale price for 30% of the firm.

Next, commercial financing is secured so that senior partners receive up-front cash for the equity they’ve sold. These partners will have the opportunity to defer capital gains on their sale proceeds, thanks to an ESOP-exclusive tax benefit — the 1042 rollover. Over time, the firm will pay down the bank loan on the employee trust’s behalf, using pre-tax dollars.

Steps are also taken to make younger partners whole post-scrape. A stock appreciation rights plan is developed to deliver formal equity-sharing opportunities to established team members with longer time horizons. They’ll also have opportunities to sell their retained equity to the firm’s employee trust in the future, potentially with rights to exchange some of their shares for warrants. New partners will receive standard ESOP allocations and consideration to take part in the firm’s supplemental incentive program (at leadership’s discretion).

Either through retained equity or ESOP shares, the firm’s next generation of leaders will have concrete opportunities to monetize their stake in a more efficient, employee-owned firm — one that is retaining earnings for internal investment or potential acquisitions and realizing enhanced cash flow, fueled by the ESOP’s tax incentives.

From initial conception to final negotiations with an independent trustee, the transaction takes roughly six months to finalize. An experienced ESOP investment banking advisor and knowledgeable ERISA counsel help keep everything on track. In the end, retiring partners gain liquidity while remaining team members earn broad-based equity upside and additional incentives in a firm that’s primed for greater competitiveness — one in which all staff are rowing in the same direction to grow the practice over time.

What makes a good CPA ESOP candidate?

ESOP strategies are generally geared for top 500 accounting firms that aspire to sustainable, long-term growth. There must be an appetite for broad-based ownership and a willingness to build internal capacity. To build an employee stock ownership plan is to bet on yourself.

It’s not the right shareholder liquidity solution for every firm. But for forward-looking firms with leadership teams that seek market leadership for the foreseeable future, employee ownership represents a powerful tool. ESOPs take the industry’s greatest challenge — attracting, retaining and rewarding talent — head on, while aligning all staff behind a common goal at independent, CPA-led firms.

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House passes tax administration bills

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The House unanimously passed four bipartisan bills Tuesday concerning taxes and the Internal Revenue Service that were all endorsed this week by the American Institute of CPAs, and passed two others as well.

  • H.R. 1152, the Electronic Filing and Payment Fairness Act, sponsored by Rep. Darin LaHood, R-Illinois, Suzan Delbene, D-Washington, Randy Feenstra, R-Iowa, Brad Schneider, D-Illinois, Brian Fitzpatrick, R-Pennsylvania and Jimmy Panetta, D-California. The bill would apply the “mailbox rule” to electronically submitted tax returns and payments to allow the IRS to record payments and documents submitted to the IRS electronically on the day the payments or documents are submitted instead of when they are received or reviewed at a later date. The AICPA believes this would offer clarity and simplification to the payment and document submission process while protecting taxpayers from undue penalties.
  • H.R. 998, the Internal Revenue Service Math and Taxpayer Help Act, sponsored by Rep. Randy Feenstra, R-Iowa, and Brad Schneider, D-Illinois, which would require notices describing a mathematical or clerical error to be made in plain language, and require the Treasury to provide additional procedures for requesting an abatement of a math or clerical error adjustment, including by telephone or in person, among other provisions.
  • H.R. 517, the Filing Relief for Natural Disasters Act, sponsored by Rep. David Kustoff, R-Tennessee, and Judy Chu, D-California. The process of receiving tax relief from the IRS following a natural disaster typically must follow a federal disaster declaration, which can often come weeks after a state disaster declaration. The bill would provide the IRS with authority to grant tax relief once the governor of a state declares either a disaster or a state of emergency and expand the mandatory federal filing extension under Section 7508(d) of the Tax Code from 60 days to 120 days, providing taxpayers with more time to file tax returns after a disaster.
  • H.R. 1491, the Disaster related Extension of Deadlines Act, sponsored by Rep. Gregory Murphy, R-North Carolina, and Jimmy Panetta, D-California, would extend the amount of time disaster victims would have to file for a tax refund or credit (i.e., the lookback period) by the amount of time afforded pursuant to a disaster relief postponement period for taxpayers affected by major disasters. This legislative solution would place taxpayers on equal footing as taxpayers not impacted by major disasters and would afford greater clarity and certainty to taxpayers and tax practitioners regarding this lookback period.

“The AICPA has long supported these proposals and will continue to work to advance comprehensive legislation that enhances IRS operations and improves the taxpayer experience,” said Melanie Lauridsen, vice president of tax policy and advocacy for the AICPA, in a statement Tuesday. “We are pleased to work closely with each of these Representatives on common-sense reforms that will benefit taxpayers, tax practitioners and tax administration and we’re encouraged by their passage in the House. We look forward to continuing to work with Congress to improve the taxpayer experience.”

The bills were also included in a recent Senate discussion draft aimed at improving tax administration at the IRS that are strongly supported by the AICPA.

The House also passed two other tax-related bills Tuesday that weren’t endorsed in the recent AICPA letter. 

  • H.R. 1155, Recovery of Stolen Checks Act, sponsored by Rep. Nicole Malliotakis, R-New York, would require the IRS to create a process for taxpayers to request a replacement via direct deposit for a stolen paper check. If a check is determined to be stolen or lost, and not cashed, a taxpayer will receive a replacement check once the original check is cancelled, but many taxpayers are having their replacement checks stolen as well. Taxpayers who have a check stolen are then unable to request that the replacement check be sent via direct deposit. The bill would require the Treasury to establish processes and procedures under which taxpayers, who are otherwise eligible to receive an amount by paper check in replacement of a lost or stolen paper check, may elect to receive such amount by direct deposit.
  • H.R. 997, National Taxpayer Advocate Enhancement Act, sponsored by Rep. Randy Feenstra, R-Iowa, would prevent IRS interference with National Taxpayer Advocate personnel by granting the NTA responsibility for its attorneys. In advocating for taxpayer rights, the National Taxpayer Advocate often requires independent legal advice. But currently, the staff members hired by the National Taxpayer Advocate are accountable to internal IRS counsel, not the Taxpayer Advocate, creating a potential conflict of interest to the detriment of taxpayers. The bill would authorize the National Taxpayer Advocate to hire attorneys who report directly to her, helping establish independence from the IRS. 

House  Ways and Means Committee Chairman Jason Smith, R-Missouri, applauded the bipartisan House passage of the various bills, which had been unanimously passed by the committee.

“President Trump was elected on the promise of finally making the government work better for working people,” Smith said in a statement Tuesday. “This bipartisan legislation helps fulfill that mandate and makes improvements to tax administration that will make it easier for the American people to file their taxes. Those who are rebuilding after a natural disaster particularly need help filing taxes, which is why this set of bills lightens the load for taxpayers in communities struck by a hurricane, tornado or some other disaster. With Tax Day just a few days away, we must look for common-sense, bipartisan ways to make filing taxes less of a hassle.”

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Accounting

In the blogs: Many hats

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Teaching fraud; easement settlement offers; new blog on the block; and other highlights from our favorite tax bloggers.

Many hats

  • Taxbuzz (https://www.taxbuzz.com/blog): There’s sure an “I” in this “teamwork:” What to know about potential IRS and ICE collaboration.
  • Tax Vox (https://www.taxpolicycenter.org/taxvox): How IRS data would likely be unhelpful validating SNAP eligibility.
  • Yeo & Yeo (https://www.yeoandyeo.com/resources): How financial benchmarking (including involving taxes) can help business clients see trends, pinpoint areas for improvement and forecast future performance.
  • Integritas3 (https://www.integritas3.com/blog): One way to take a bite out of crime, according to this instructor blogger: Teach grad students how to detect, investigate and prevent financial fraud.
  • HBK (https://hbkcpa.com/insights/): Verifying income, fairly distributing property, digging the soon-to-be-ex’s assets out of the back of the dark, dark closet: How forensic accounting has emerged as a crucial element in divorces.

Standing out

Genuine intelligence

  • AICPA & CIMA Insights (https://www.aicpa-cima.com/blog): How artificial intelligence and other tech is “Reshaping Finance,” according to this podcast. Didem Un Ates, CEO of a U.K.-based company offering AI advisory services, tackles the topic.
  • Taxjar (https:/www.taxjar.com/resources/blog): How AI and automation can help even the knottiest sales tax obligations and problems.
  • Dean Dorton (https://deandorton.com/insights/): Favorite opening of the week: “The madness doesn’t just happen on college basketball courts — it also happens when your finance team is stuck using a legacy on-premises accounting system.”
  • Canopy (https://www.getcanopy.com/blog): Top client portals for accounting firms in 2025.
  • Mauled Again (https://mauledagain.blogspot.com/): Despite what Facebook claims, dependents have to be human.

New to us

  • Berkowitz Pollack Brant (https://www.bpbcpa.com/articles-press-releases/): This Florida firm offers a variety of services to many industries and has a good, wide-ranging blog. Recent topics include the BE-10, nexus and state and local tax obligations, IRS cuts and what to know about the possible bonus depreciation phase out. Welcome!

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Accounting

Is gen AI really a SOX gamechanger?

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By streamlining tasks such as risk assessment, control testing, and reporting, gen AI has the potential to increase efficiency across the entire SOX lifecycle.

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