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Frozen ESOP question


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New to the board and not an ESOP person...lol

My company has a frozen ESOP plan and since it's been frozen we have been paying the retirees by buying back the company's stock annually and have been retiring the Company stock at that time...since it's an equity transaction within the Company (and not the ESOP), we haven't been taking a tax deduction for this "contribution".  We were told at some point in time that the ESOP couldn't make a "contribution" to the ESOP since it was frozen, so we have been retiring the stock.  

So, my question, is this.   Although our plan is frozen, can our Company still make a contribution of cash to the ESOP to pay the retirees?  Therefore, we would take a tax deduction and the shares the ESOP bought back I assume will be re-allocated (and not retired) among the remaining participants.  

Any thoughts would be greatly appreciated.  Is so, is there some authoritative guidance you can provide that I can reference that would be great...

We are now out of NOL carryforwards and it doesn't make sense that, although frozen, a Company paying retirees can't contribute cash to the ESOP to pay retirees and take a tax deduction....We are generating a sizable taxable gain due to selling assets to pay the retirees..so our past position doesn't make any sense to me...

Thanks so much for your help and expertise.  

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My guess is you need to find a good ESOP TPA and/or attorney to get the best answer but here are some opening thoughts.

What do you mean by frozen?   I really think the answer to that question is going to matter a lot.  Frozen is not a word normally used to describe an ESOP.  The few times I have seen it used it means no more new employees can enter the plan and become participants.  Is that what it means or does it mean something else? 

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Correct ESOP Guy...to my knowledge, all it has meant is that no new employees can enter the plan...So, no new employees entering the plan and distributions are being paid out annually to retirees, etc. that's the primary activity.  

Somewhat hesitant to re-open due to dilution of current participants since the assets are not growing and the Company is not interested in putting additional assets into the plan.  

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Maybe that's a better question..if the plan is truly frozen, could we open up the plan to allow contributions to fund retiree distributions, but still not allow new participants to enter the plan?

We don't won't to open the plan to new participants.  

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The reason you might not be able to reopen (I kind of like the defrost comment!) the ESOP is your are not going to be able to pass required testing.  You have to show the plan covers enough people.  If most of your Highly Compensated employees are in the ESOP from before it was frozen and lots of rank and file employees are "frozen out" of the plan it will never pass the tests. 

The only way to know for sure is to do what RLL says talk to an experience ESOP professional and they can run testing projections.  Also, they could run projections on what would happen if you start letting people back into the plan and giving them contribution allocations. 

I am more convince now then my first reply you can't get quality answers without spending some money to get some professional help from someone who knows ESOPs and can see all the data. 

 

JUST SAW YOUR NEW QUESTION WHILE TYPING THE ABOVE:

As I stated above most likely you can't make contributions and not let people in.  You will most likely fail critical nondiscrimination testing. 

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yes, C corp...the plan has been frozen for close to 10 yrs and probably about 1/2 of our top mgmt are "frozen" out of the plan since they are relatively new..and it still has 10,000 plus participants, so it may pass the test...but, we def don't won't new employees in the plan

We're tracking down 2 attorney's we've worked with in the past, but time is of the essence and it doesn't need to be 2 weeks from now so I was just curious...

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If our circumstance is correct, then that means a company would have to buy back all of the stock before the "freeze" to take a tax deduction...that doesn't make sense since most companies don't have that type of liquidity all in one swoop...

And I've never heard of ESOP plans having huge tax liabilities...Since we are selling assets to pay the retirees, the large tax consequences actually dilutes the other participants tremendously...

Hopefully our position in the past is misinformed

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You might want to go to the ESOP Association website or the NCEO website and look at their service providers sections for an ESOP TPA if you don't already have one that specializes in ESOPs. 

They could help you with running projected tests.

Since you are a C Corp one other idea you could look at but would need to run projections on is dividends.  It is possible to make C Corp dividends tax deductible when paying them to an ESOP.  You didn't say if the ESOP owns 100% of the stock or not this won't be cash efficient if there is a lot of outside shareholders as they have to get their share of a dividend. 

The thing is to make the dividends deductible you would have to give the 10k participants a choice to keep the cash in the plan or get a the dividend as a check.  Obviously, if most of them ask for the check you have your deduction but the money isn't in the ESOP to repurchase the shares.  But a lot of the testing doesn't apply to dividends.  

Once again I think you are going to just need to get someone who can look at all the numbers. 

 

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2 minutes ago, bkidd said:

If our circumstance is correct, then that means a company would have to buy back all of the stock before the "freeze" to take a tax deduction...that doesn't make sense since most companies don't have that type of liquidity all in one swoop...

And I've never heard of ESOP plans having huge tax liabilities...Since we are selling assets to pay the retirees, the large tax consequences actually dilutes the other participants tremendously...

Hopefully our position in the past is misinformed

I am not 100% sure what you mean by all of this.  So you can't fund the payments from operating cash flow?  That happens at times and in effect the company/ESOP are forced to find an outside buyer as there is no other way to fund the repurchase obligation. Unless what you are selling is a sinking fund. 

But isn't the fact you are currently taking the stock out of the ESOP and putting it into treasury anti-dilutive? 

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No, there is not enough cash flow from operations to fund the distributions..so, the Company sells assets, then has the cash to pay the retirees..

The ESOP owns 100% of the Company...we don't feel taking stock out of the ESOP is anti-dilutive...so, if the asset values stay the same from year to year, the assets go down by the same amount as equity distributions..and therefore, it theoretically shouldn't impact the remaining participants.

 

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