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Merging a current ESOP into existing 401k plan for c corp


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What are the pros and cons of merging an esop with half the shares unallocated into an existing 401k compared to a termination of the same esop??

Great case study! Anyone want to weigh in???

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What is the goal?

I mean why not simply make the ESOP a KSOP and get rid of the 401(k)- merge it into the KSOP?  That off the top of my head seems simpler unless they no longer want the ESOP. 

What is going to happen to the unallocated shares in the ESOP if you merge with the 401(k)?  

I guess I am still really stuck back at what is the goal before I opine too much.   Lack of facts here seem to make giving a good answer hard.  

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Thanks for the reply! 

You assumed correctly that they don't like the ESOP (second generation wants majority control of the company) owning 40% of the company. They would like to buy those shares but will have to pay a high premium for those shares unless done thru the repurchase obligation, correct? Considering the termination, that would require 100% vesting and I presume all the unallocated shares would have to be distributed, correct? That's why we considered looking at a merge so we could consolidate 2 plans into one and continue to distribute unallocated shares to the K plan. Is this a violation of anything? We haven't consulted with counsel yet about either of the 2 options and now the KSOP option.  This is exploratory at this stage and with the complexity of an ESOP we want to be careful not to violate the rules for the EEs. Pros and cons of both options along with your suggestion to consider a KSOP. If we "reverse" merge the 401k into a converted ESOP to KSOP, what advantages appear? Very curious regarding simplicity as this is always preferred. 

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Sorry, but your merge idea doesn't work.  Only an ESOP can have the unallocated share and the related loan.  

At this point unless they simply want to get rid of one of the plans there isn't much value in a merge that I am seeing.   I just thought merging to a KSOP would be simpler because you wouldn't have to deal with the unallocated shares.  You could keep the loan and the suspense share in place.  Since the goal doesn't focus mostly on getting rid of a plan as much as changing who owns the company a KSOP doesn't make  difference. 

As for the goal of the minority owners slowly taking a majority of the stock by distributing the share from the ESOP and I assume making the shares treasury stock is an interesting one.   It would slowly result in the ESOP owning a smaller percentage of the over all stock and the outside owners a larger percentage.

You seem to understand this but currently the ESOP being the majority owner gets in effect a premium on the stock price for being the majority owner.  When the ESOP's ownership fell to a minority the stock price would get hit with a discount for being a minority owner and all the remaining shares would lose value.  I would research if the fiduciaries have to account for that and make some kind of adjustment.   I mean this plan would result in loss of value to participants in a plan and it was because of the direct actions of the Plan Administrator and Trustee.  They have  a duty to not lose the participant's value.  I see a possible big fiduciary problem here.  Maybe one of the attorneys who come around here who knows ESOPs will opine on that issue. 

This is going to be complex enough you need a good ERISA attorney who knows ESOPs and doesn't merely dabble in ESOPs.    If the current trustee is an inside trustee, and especially if the inside trustee is one of the 2nd generation people who could be seen as having a conflict of interest regarding this, I would look to getting an outside trustee.  

If they have the ability to simply buy all the shares from the ESOP that would make thing easier but that could take more cash than anyone has at this point.   

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My initial thought is to get an ERISA lawyer who deals with ESOP fiduciary issues to help you.  Often in these situations the trustees of the ESOP may be the managers of the company and they may be the ones that are looking to change things around.  The ESOP trustees must work solely for the benefit of the ESOP participants,.  The DOL has strong opinions on the valuation of ESOP securities and it would be good to have a lawyer that is expert in this area help you.  You might need two lawyers -- one for the ESOP trustees and one for the minority shareholders who are trying to get control of the company through the purchase of allocated and unallocated shares from the ESOP.

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TPG:

 

ESOP Guy says the unallocated shares need to reside in an ESOP. That renders most of what I have to say irrelevant. But pretend you really could merge the ESOP into a K plan, or that you allocate all the shares beforehand, or that you want to be prepared for the next time this situation comes up (which is why I am jumping in). I am not convinced you’ve begun to think about the other hassles that could be presented by your proposed merger, so let me talk you out of considering a merger for another reason besides the presence of unallocated shares.

 

For anyone else reading this, this post deals only with a few general document-related issues I see as being potentially relevant. Those of you having no interest in documents are advised to bypass this post. My post arises from my experience with plan documents in general, not from having expertise with ESOPs. I am not an ESOP expert. The reason why I started this project was out of curiosity, and having finished it, I figured I would post it. My comments are offered only because all too often I have found that many transactions occur without first considering (1) the impact of the transaction on the document(s) and (2) the impact of the document(s) on the transaction.

 

TPG, let me remind you that you used the word "case study."  (Here is a case study.)

 

The Documents

 

If the K plan is not a preapproved plan, bear in mind that if the plan already has a determination letter, then the employer cannot obtain another determination letter except upon plan termination (IRS Revenue Procedure 2016-37). I would think twice before having a K plan with merged ESOP funds that cannot obtain a current determination letter covering the merger, even if both plans have pre-merger reliance. I would also think twice about having a merger like this be the subject of an initial determination letter request, since the entire history of both plans will be under the IRS microscope in that case.

 

If the surviving K plan is not going to be a preapproved plan, there is nothing of interest in what follows.

 

If the K plan is going to be a preapproved plan, you have a better potential path toward reliance, but I recommend that you proceed with an abundance of caution. You are likely to have 411(d)(6) protected benefits in the ESOP that are not compatible with any preapproved non-ESOP plan document, such as unallocated suspense accounts, the treatment and distribution of dividends, separate accounting and vesting for tax credit contributions, synthetic equity (probably not in this case, but just saying), and/or provisions relating to the forfeiture or distribution of company stock, etc.

 

My concern is not related to the fact that ESOPs could not use preapproved documents prior to Cycle 3. My concern is that even if a provider has a Cycle 3 preapproved ESOP, that firm’s preapproved non-ESOP 401k plan most likely is not designed to accommodate any provision that is unique to an ESOP. [Background: My reading of Revenue Procedure 2017-41 is that the IRS did not allow providers to submit an “all-purpose” AA for a K plan’s Cycle 3 approval. Although that Procedure provides that providers could have provided an AA that has combined its K plan, PS-only plan, and non-target-MP plan features into a single AA, a provider could not combine ESOP features into that same AA. It appears to me that the cited Procedure required any plan with ESOP provisions to be the subject of a separate submission by the document provider. I suspect that the IRS would therefore have declined to review any non-ESOP K plan that contained any ESOP-unique provision, such as provisions containing details regarding a merger of an ESOP into the K plan. I am familiar with three Cycle 3 preapproved K documents, and none of them have ESOP-like provisions.]

 

If the K plan is still in its PPA incarnation, and you conclude that modifications to that PPA preapproved document are necessary to accommodate protected benefits arising in the ESOP, then I think you should presume that you would potentially transform the preapproved K plan into an individually designed plan. I say that because no ESOP feature was permitted under the preapproved program for the PPA remedial amendment period. For that reason, I recommend that the K plan be restated to a Cycle 3 plan document prior to the merger, as then you could argue that modifications (if any) to any preapproved plan on account of an ESOP protected benefit is at least a modification that is within the subject matter that is now covered by the preapproved plan program. Even if you would lose reliance (in the absence of an IRS 5307 submission), you wouldn’t necessarily drop out of entitlement to six-year restatement cycles. And if you decided to submit the modifications to the IRS, you could start by using Form 5307 (though I would be prepared for a request from the IRS to re-submit using a Form 5300). That is why I stated earlier that there appears to be a potential path to formal and full reliance via a preapproved K document. You would not be asking for a determination letter for an ESOP, but for a modified preapproved Cycle 3 401K plan to protect 411(d)(6) benefits upon plan merger, and the fact that the modifications are ESOP-related is no longer going to throw you out of the preapproved plan program.

 

You might also want to ask the provider of the K preapproved plan whether that provider thinks that their non-ESOP Cycle 3 K plan can be used as-is or modified for this purpose. However, I highly recommend that you provide a list of the specific ESOP-related protected benefits that you have identified as needing continued protection in the non-ESOP K plan as part of your inquiry to the document provider, especially if the provider does not provide a Cycle 3 ESOP (which would be a general indicator of how much experience they have with ESOPs). You want the provider to be clear as possible about what exactly you have in mind. Making such contact with the provider might be one of the first tasks to assign to the expert ESOP counsel that has been recommended by prior commentators in this thread.

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