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Guest mikeymo
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Guest mikeymo

I have been involved in designing defined contribution plans but I have never worked with ESOPS. I ran into an old friend at a class reunion and he contacted me when he returned home for my opinion.

Bottom line is he has $200,000 in retirement accounts he wants to use for the purchase of his own business and does not want to pay income taxes on this money.

He has been approached by an ERSOP promoter with this concept.

He establishes a C Corp. C Corp. then establishes an ESOP. Once the ESOP is established, he rolls his $200,000 into the new plan. Then, the ESOP purchases the stock of his C Corp. for $200,000.

The C Corp. now has $200,000 in cash to go to the bank and use as a down payment to purchase a new operating business.

I told him I smelled something funny as this would be too good to be true. He has some M and A experience so he knows the operating business he buys would become participating under his ESOP. And the fees for annual financials may add up to making all of the gyrations he going to go through not worth it.

The company that administers these plans for sponsors files and receives for letters of approvals with the Service. But, where I see a problem is how can an ESOP buy employer securities that are worthless on the purchase date but the day the check clears the business is then worth $200,000?

Has anyone else heard of this or help me shoot arrows at it to help my buddy stay out of trouble?

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I agree that the ESOP can't pay $200,000 for a worthless business. But maybe he just has the facts wrong. Maybe the business will be bought first -- on credit -- and then sold to the ESOP?

But I still have a problem with the transaction. When someone says, "[H]e has $200,000 in retirment accounts he wants to use for the purchase of his own business," I say, "You're telling me right there that you can't do it."

ERISA 404 requires that fiduciaries act "solely in the interest of participants" and "for the exclusive purpose of...providing benefits to participants." He has to do the deal because he thinks that the investment is a good idea from the benefit plan's perspective, not his personal interests outside the plan. If the business isn't even in existence yet, he can't possibly make the judgment that this is a good investment for the plan.

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Guest jfp

1. In order to qualify for the PT exemption for the purchase of employer securities, the ESOP cannot pay more than "adequate consideration" (essentially, fair market value). If a corporation is a shell, and the ESOP will pay $200,000 for 100% of the stock, after which the corporation's only asset is the $200,000, can you make the argument that the stock is worth at least $200,000? Strange, but interesting.

2. If this is a rollover account of the one individual, who would ever challenge the transaction on Section 404 grounds (the individual is not going to sue himself/herself)? I guess, theoretically, the DOL could do it, but why would it bother?

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Guest mikeymo
Guest Pensions in Paradise

First and foremost, you need to have your friend talk to an ERISA attorney.

The plan described on the promoters website is NOT an ESOP. It sounds like a regular defined contribution plan which invests in employer stock.

There are so many issues with what they propose that it is actually laughable.

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An ESop is a leveraged financial vehicle- the employer or the owners transfer stock to the ESOP which procures a loan from a bank in order to pay the owner for the transfer of the stock. The bank gets the stock as collateral for the loan and also has a personal guarantee of the owner for payment of the loan. The corporation makes dedcutible contributions to the plan each year to pay off the loan and the trustee releases stock to the participants as the payments are made. At the end of the loan the participants own 200k in stock held in the esop.

The Esop cannot go to the bank and use the 200k to purchase a new business because of 1. the unrelated business income tax and 2. an esop can violate the diversification requirements for investing plan assets only for the purchase of employer stock or RE. Otherwise the plan cannot invest more than 10% of the assets in employer property.

Your friend should contact a tax attorney to advise on the only way the deal can be structured- Have an IRA purchase the initial offering of stock when the busines is incorporated so that the dividends will be paid tax free to the IRA. If the business will not pay dividends then the purchase is not viable.

If your friend wants to purchase the business why not just have the IRA buy it- even though that would not be a sound investment decision.

mjb

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Guest jfp

1. The 408(e) exemption is available to a profit sharing plan as well as an ESOP, and the 10% limitation would not apply to a profit sharing plan or an ESOP.

2. If the IRA buys the company there could be PT issues for which the 408(e) exemption is not available. (I'm not saying that there necessarily would be PT issues, but if there are - particularly of the self-dealing variety - there is no exemtpion.)

3. The non-ESOP idea is even better than the ESOP structure. The individual's rollover account owns the stock of the corporation, and the other participants invest in other stuff without any need to comply with the ESOP requirement that the plan be "designed to invest primarily in employer securities."

I agree that this deal raises a million issues, but it does not appear to be dead on arrival.

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Do these people provide a legal opinion to support the claims they make about how easy it is to transfer plan asets to a corporation? As I understand it, all that happens is that the IRA assets are rolled into the plan and the plan become the sole owner of the co. While the plan is not subject to the fiducary provisions of ERISA if there are no employees, any scheme to use plan assets for the benefit of the owner of the business in his personal account would violate the PT rules of IRC 4975 and result in a 15% excise tax.

mjb

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The IRS has recently addressed this situation. On 5/9/03, the Employee Benefits Committee of the Section of Taxation of the American Bar Association held its annual "Questions and Answers" session with representatives of the IRS and Treasury. The report of the session can be found at http://www.abanet.org/jceb/2003/qa03irs.pdf .

In Q & A # 9, the question was asked as to whether an arrangement that seems almost identical to the "ERSOP" described above violates the IRC section 401(a)(4) nondiscrimination requirements. The ABA question included a proposed response that no IRC requirement was violated by the arrangement.

The IRS response disagreed and indicated that various aspects of the nondiscrimination requirements would be violated, including the "effective availability" requirement.

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  • 2 months later...
Guest PORTE

I'm not sure about that ERSOP.com guy. Wasn't ERISA 1974? They are actually filing for qualification and they are getting it. These are prototypes that they amend and add like two paragraphs to allow for investment in employer securities and that the only investment in the employer securities can be in the rollover account.

If the IRS lets this get by and approves it with the amendments right up front, how can they say in the whitepaper that they don't think this is allowed?

4975(d)(13) allows it.

Are we all missing something? These guys found a loophole for small business owners, the IRS is setting precedent by issuing qualification letters.

I want to hear more about these.

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I notice that on the esop.com website they do not claim that the have actually done these ersops, instead the claim is made that they have put in over 300 of these plans but notice ERSOPs are not listed among the "these".

I also see no mention of IRS or other approval of their ERSOP. And I find it curious that they did not use a sample letter as sales material. The IRS Determination Letter seems to be related to the 401(k) and Trust and NOT to the ERSOP.

To me it is a site well written so as to not be specific.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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  • 2 weeks later...

Isn't there a requirement that an ESOP have recurring contributions? If all of the contributions are in cash, there will be a 401(a)(4) issue if the other employees don't have the right to purchase stock.

An ESOP must be designed to invest primarily in employer securities. If only one rollover and no employer contributions are invested in employer securities, I question whether that requirement will be met.

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Guest PORTE

Again!, It's NOT an ESOP, it's a normal DC plan designed to allow for investment in ER securities in the rollover account only.

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  • 2 weeks later...

I guess that this ERSOP idea is spreading. This is a recent article that went to many accountants:

http://www.accountantsworld.com/news/currn...spx?q1=43635112

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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  • 10 months later...
Guest oxford46105

I have been searching for more info on these plans frequently referred to as Entrepreneur Rollover Stock Ownership Plans, the last couple of weeks. Here is some of what I have found out on the internet:

http://www.sba.gov/ca/santa/newsletter.pdf

SmallBusinessAdmin Santa Ana finds that ERSOP is covered by ERISA

www.ersop.com

www.benetrendsinc.com

www.guidantfinancial.com

www.rainwatercpa.com

here are the typical steps need as described my several of these internet sites.

Rollover Steps

The Corporation

You will need to incorporate. This can be handled by our service provider, your attorney or you (not recommended). Buyers forming an Illinois corporation are urged to consider the IL Secretary of State’s $300 expediting fee to avoid unreasonable delay.

The ERSOP

Our service provider will prepare the documents with special language to establish your new Profit Sharing 401(k) Plan and Trust. With your new plan documents, corporate resolutions, and Tax Identification Number, your bank will open a checking account for your new “Plan.” The “Plan” is submitted to the IRS for a determination letter. There is a $700 filing fee that may be waived if there is at least one highly compensated employee (non-owner).

The Rollover

In order to be eligible for a rollover from your last employer’s retirement plan, you must have terminated employment with that employer. You are assisted in preparing any forms to secure the “direct rollover” of your retirement assets into your new Profit Sharing Plan & Trust checking account. You, as trustee, will transfer funds from the Profit Sharing Plan and Trust account to the corporate account. Your new corporation will issue share of its stock to the Profit Sharing Plan & Trust. The corporation will now have the cash and the Profit Sharing Plan & Trust will own the corporation’s stock.

Annually

The Plan will require administration, allocations, trust accounting and federal government reporting every year for an $800+ annual fee. Each corporate year-end, our service provider will estimate the tax-deductible contributions that you can make to your new tax-deductible retirement plan.

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Why isnt the sale of stock to the Profit sharing plan trust by the 100% owner of the business a prohibited transaction under IRC 4975©(1)(A)- sale of plan assets to disqualfied person? See SD Cooper ERSOP presentation slide #10. Under IRC 4975(e)(2)(E) a disqualfied person includes the owner of 50% of the stock of a corporation. Is there a PTE for this transaction?

Also ERISA only covers a plan with a least 1 common law employee.

mjb

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Note that the SBA (at least not in the Newsletter link provided) did not say why ERISA covered ERSOPs nor in what respect it did. We also do not know what sort of ERSOP they were referring to.

The accepting of ERSOPs for a particular, or even any, purpose by the SBA has no bearing on its acceptance by the IRS etc. What does the IRS have to say? What is in the IRC etc? What has the DoL said about ERSOPs and about Prohibited Transactions?

The fact that an item is being promoted by any number of websites etc does not make it viable, compliant or anything else but "being promoted".

I noted that according to the post by oxford46105, the "Plan" will be submitted to the IRS for a Determination Letter. Has anyone yet received a favorable DT? Can someone explain why a DT rather than a PLR? And if a DT is issuable for an ERSOP what would it cover? If it is like a Qualified Plan DT, isn't there a need for a PLR in this case?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Guest PORTE

My client did receive the determination letter from the IRS. I called the IRS in Washington and spoke with them about these specific plans. They are getting favorable determination letters but the IRS has this on a watch list. They know the name of the Company(s) that are selling them. Of course, the determination letter is vague as usual and can certainly be challenged, but they have ok'd amended provisions that allow that individual participants to invest 100% of their funds into employer stock. And really that is the key here. If it is a prohibited transaction or not. I wish someone could give some real guidance on this subject. THe IRS and the DOL have to step out and say you can or can't. All of us that look at this think "NO Way!" But the parties that are selling it are telling us we are not reading the correct law provisions. Frustrating.

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IRS determination letters only approve the form not the operation of the plan. All plans contain a provision forbidding prohibited transactions such as the sale of plan assets to the owner of the business for which there are plenty of PLRs and DOL opinion letters on file and for which no further guidance is needed. Clients who want to to engage in this type of transactions need to hire expert counsel to advise of them of the rules not rely on the advice of promoters who make money off of selling these schemes (e.g., accounting firms who sell tax shelter opinions). As warren buffet reminds us a fool and his money are easily parted. A prohibited transaction must be reported on the 5500 for the plan and the 15% excise tax paid by the person who benefits from the transaction with the plan.

mjb

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PORTE: Could you provide the sections that you are being told incorrectly apply to ERSOP transactions. Note that P. 7 of Internal Revenue Manual Section 4.72.11.3 which is listed and linked in the S D Cooper ERSOP materials expressly states that a PT includes a sale or exchange of property between a disqualified person such as the owner of the sponsor and the plan.

mjb

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PORTE

Did the IRS tell you why they had a watch list?

Have you seen and read any of these DLs? What is covered?

Yes, the DL might say that you can invest in employer stock, but I bet it does not say who can nor give guidance for situations where the investor is also the employer or sole shareholder of the employer/sponsor etc.

The devil is always in the details and Determination Letters do not go into nor approve the details of design and operation..

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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IRS determination letters do not review whether an investment under a plan would be a prohibited transaction under IRC 4975.

A prohibited transaction under 4975©(1) includes the sale, exchange or loan of property between a plan and the owner of >50% of the interest of the employer who sponsors the plan.

4975(d)(13) exempts from the PT rules any acquisition, sale or lease of employer securities between the plan and a >50% owner of the employer for adequate consideration under ERISA 408(e). In order to qualify for this exemption a plan must have at least 1 common law employee and secure an appraisal from an independent third party of the fmv of non publicly traded securites it acquires. The plan cannot purchase stock for an arbitrary amount asked by the owner. If the IRS declares ERSOPS to be a listed transaction as an abusive tax shelter it will get the names of all employers who adopted the plan from the prototype sponsor and will audit the plans to assess the 15%/100% PT tax on the owner for violation of the PT rules if there is no appraisal or if the plan is not subject to ERISA.

A better way to attain investment objectives is to rollover the distribution from the qualified plan to an IRA. Under the Swanson decision, the owner of the IRA can direct the custodian to purchase an initial issue of stock from a C corp in which the owner is the sole director and the purchase price will be the initial capital of the Corp in a tax free transaction in which the IRA owns the corp and will receive all dividends tax free. No appraisal is required because the IRA is not subject to ERISA. The IRA can invest in other businesses subject to the PT rules of IRC 4975. This transaction is recognized by the courts and the IRS and doesnt require a fee to the sponsor to receive a determination letter. However you have to find a custodian who will hold assets of non publicly traded corporations.

mjb

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  • 4 years later...

The IRS has issued guidance on ERSOPs - The IRS calls these transactions ROBS.

Guidance available here http://www.irs.gov/pub/irs-tege/rollover_guidelines.pdf.

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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