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Leveraged ESOP - not allocating shares in a given year?


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I have always been under the impression that in an exempt leveraged ESOP where the proceeds were used to purchase the stock from the owners, in order to avoid the prohibited transaction rules there must be a release from encumbrance EACH plan year based upon the loan repayment schedule. The repayment schedule must be at least as rapid as either the principal only or the principal plus interest method, as per 54.4975-7(b)(8).

Is there any legitimate circumstance whereby such a leveraged ESOP can NOT release shares for a given plan year? (Not talking about plan termination or bankruptcy/insolvency situations either, just "normal" ongoing plans.)

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Here's an easy one. The loan agreement stipulates that loan prepayments are applied to the front end of the loan instead of the back end. If the loan is prepaid, you essentially have a payment "holiday" until you catch up to the original amortization schedule.

Marcus R. Piquet, CPA

American ESOP Advisors LLC
5995 Brockton Ave Fl 2, Riverside, CA 92506-1833
(951) 779-1124 (v) (951) 346-0896 (fax)

mpiquet@AmericanESOP.com

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B:

I concur with Marcus. And here are a couple of other scenario's as well:

The Stock Purchase Agreement and note state that a pre payment of the note in any given year can be used to offset future stated annual payments. Thus, perhaps due to prior pre payments the employer chooses to skip a payment until the proceeds of the pre payment are used up.

Alternatively,

The loan payment date is set so that in a given year payments on the loan note/contribution is accrued, allocated and the shares are released for a prior plan year.

As an example the Stock Purchase Agreement and loan note sets the loan date of 9/1. Client has a plan year/fiscal year of 12/31.

For fye/pye 12/31/2013 the employer files an extension for the corporate tax return to 9/15.

The 9/1/2014 payment is accrued, allocated and shares are released for the 12/312013 plan year

For 2014 fye/pye the corporation files its return by 3/15/2015 with not contribution/deduction.

The 9/1/2015 payment is picked up for the 2015 fye/pye and the contribution/payment is deducted.

In essence the payments are on time, the deductions and contributions are in compliance and for the plan year end 2014 there were no payments/contributions and no share release.

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Thank you both! But I'm still a little confused (obviously) - the language in the regulations I referenced seems to say that at least for the principal only method, annual loan repayments are required. Is this correct? Or does it actually mean that it must "provide for" at least annual payments, but if you prepay, that satisfies the requirement as you have discussed? I assume it is the latter, but I just want to make sure.

Does your prepayment scenario apply only if the principal and interest method is being used?

Is there additional guidance that clarifies this further?

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B:

The share release formula is not pertinent to the discussion of the timing of contributions, payments and timing of allocations. Or, the example of timing of contributions payments and allocations discussed above can be done regardless of the share release formula elected to be used.

You will have to enlighten me on the regulations you are referencing. My guess is you are perhaps not understanding or misinterpreting whatever regs. you have referenced..

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B:

The Reg you note governs the share release formula. The reg requires that each plan year during the duration of the loan, the number of securities released must equal the number of encumbered securities held immediately before release for the current plan year multiplied by a fraction.

The reg does not stipulate for which plan year those released shares must be allocated. As noted in the examples that Marcus and I gave you the Share Release is happening on a plan year basis. However, the allocation of those shares may be allocated in a different plan year.

As it relates to the Principal Only Share Release Method the regulation stipulates Rule One;

"The first rule is that the loan must provide for annual payments of principal and interest at a cumulative rate that is not less rapid at any time than level annual payments of such amounts for 10 years."

I have bolded and underlined the important wording "cummulative rate".

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