RLL

A sale of stock does not involve a shareholder vote. It is an investment decision to sell by the owner of the stock. It does not involve a corporate action (such as a merger) that requires a vote of shareholders. No vote needed, so there’s no vote to pass-thru to ESOP participants.

Under the ESOP loan regulations and IRS guidelines, only contributions (made for loan repayment purposes), dividends on the shares that were acquired with the loan proceeds, and cash proceeds from the sale of suspense account shares (in certain limited situations) may be applied as payments on an ESOP loan.

You might consider “defrosting” (reactivating) your frozen ESOP. Talk to an experienced ESOP professional about this.

1042 treatment would not be available to the selling shareholders under these circumstances. Under a "step transaction" theory, a pre-arranged deal such as this would be treated as a sale of stock by all shareholders (including the ESOP, with respect to its existing 24% holding) to the unrelated buyer. The intervening "sale" to the ESOP would be disregarded. It's disappointing that professional advisors and trustee would be involved in structuring such a sham transaction.

The 51% owner should not have sold control of the company without offering a similar buyout opportunity to the 49% owner (the ESOP). If the "owner" received $18 million (or more) for his 51% interest, the ESOP's 49% is worth substantially more than $3.1M (it's likely worth over $17M). In light of the recent stock purchase by the President, it doesn't take an independent valuation to determine that. And it appears that both the 51% owner and the President are/were fiduciaries of the ESOP. Based on these facts, this looks like somewhat egregious violations of ERISA's fiduciary provisions, including prohibited transactions. An ESOP lawyer with litigation experience should be contacted. Or take this situation to the local office of the Department of Labor. The ESOP and its participants could be entitled to an additional $14M (or more).

An S Corp ESOP is not exempted from the put option requirement. It is exempt from the requirement that distributees have a right to demand distributions in the form of employer stock and may provide that any stock distributed is subject to an immediate buyback by the employer.

Forfeiture of otherwise vested benefits for this reason would likely violate the vesting requirements of ERISA.

Did the former owner elect under IRC Sec 1042 with respect to the sale?

Correct.

The transfer of the company stock to the PSP could be exempt under ERISA Section 408(e) if the PSP includes provisions that qualify it as an EIAP. But the transfer of the real estate to the party in interest as payment would not fall within the purview of the 408(e) exemption. Seek an individual transaction exemption from DOL.

Stock issued as a result of a stock split is treated as having been acquired at the same time as the shares with respect to which the new shares are issued.

What does the Stock Restriction Agreement say about determining fair market value for purposes of the transaction?

Seek the advice of legal counsel experienced in ESOPs and corporate governance issues.

QDROphile is correct about taking shareholder action without a vote ... if it can be done under applicable corporate law and the governing documents. It may also be possible to effect the proposed reclassification/recapitalization by an exchange of shares, without a shareholder vote. If this approach were to be followed, it may be appropriate to obtain a fairness opinion for the ESOP. If a shareholder vote is required (and action by consent is not available), the vote by the ESOP trustee must be done based on the ESOP "voting pass-through" requirement ... even if the ESOP's 30% cannot affect the result. The pass-through of voting rights likely would involve some disclosure of certain material facts, etc., to ESOP participants.

Depends largely on applicable corporate law. Issues to be addressed include the following: (a) Is a shareholder meeting and vote required or may the recapitalization be effected by an exchange of shares without a vote? (b) Is shareholder approval available by consent without a meeting? © What percentages of each separate class of stock are owned by the 70% shareholder? (d) Are there any provisions in the articles of incorporation that may affect this? You shouldn't expect an answer to such a difficult question from a message board such as this. You haven't provided enough facts. Necessary legal documents need to be carefully reviewed. I recommend that you consult with legal counsel experienced in corporate, securities, and ESOP law.

Your interpretation of the regs is correct. It essentially means that an ESOP can prepay the loan only to the extent that the employer pays contributions that are intended to make loan payments or when certain dividends on employer stock are paid to the ESOP. I don't think that this rule is "silly," as you have suggested. It is intended to protect the interests of ESOP participants and has generally worked out well for 35+ years.

There are many complex tax and other regulatory issues involved in having a bank elect S corp status. For example, certain banks are not eligible to elect S corp status. You can't expect to get sufficient guidance in a forum such as this. The folks here don't know the specific facts involved in your situation. With all due respect to ESOP Guy, a "good ESOP TPA" is not qualified to provide advice on the myriad of legal issues that should be addressed as part of this analysis. You should consult with counsel who is familiar with applicable banking regulations and S corp tax matters, as well as ESOPs, in order to properly evaluate this.

The ESOP's primary source of cash is likely to be employer contributions, particularly if this is a new ESOP. So the employer could pay all those expenses directly and then later contribute less to the ESOP. If this is not a new ESOP, the ESOP may have accumulated cash that theoretically could be used to pay those expenses. But, presumably, the employer will be making future cash contributions that could be reduced if the employer pays all those expenses. Why take the risk of an ERISA violation by having the ESOP pay those expenses? Maybe I'm missing some unique facts that make a good case for wanting the ESOP to pay the expenses.

There is a potential problem with this approach. The stock that's distributed upon termination of the ESOP will be subject to the required put option (assuming this is not a publicly-traded stock). To the extent that there is value in the stock, who will honor the put option (and purchase the shares)? The company likely has very little cash available. Even if it does have cash, the company may have no retained earnings, which may prevent the company from purchasing its own stock. A bankruptcy filing could further complicate the repurchase of stock by the company. It may be preferable to retain the ESOP, which would remain a shareholder of the bankrupt company and would be treated the same as other shareholders. What % of the company is owned by the ESOP? Who are the other shareholders?

The prior comments are right on point. It's a bad idea ... Often a gimmick used to sell "tax deductible" life insurance. Lots of potential ERISA fiduciary issues, as well as various administrative problems. Don't do it!

If the company purchases/redeems shares from ESOP distributees, there is no ERISA party in interest transaction (as the ESOP is not a party to that transaction). The fact that the company pays more than current appraised fair market value does not make the redemption a transaction subject to ERISA's prohibited transaction rules. The company and the ESOP trustee have agreed (in advance) that the company will pay the higher redemption price at the time the ESOP distributes shares.

An ETF would not satisfy the definitional requirement (for QRP) specified in IRC section 1042©(4)(A)(i).

If the participants are making an election which results in an investment in company stock under the ESOP, there may be requirements under federal and state securities laws with respect to both elective and non-elective contributions. This proposed arrangement should be reviewed by legal counsel experienced in the applicability of securities laws to employee benefit plans. The use of an independent fiduciary is advisable under ERISA, but that does not eliminate the need to comply with applicable securities laws.

See IRC section 409(h)(2)(B). The mandatory cash-out provision (including the distribution of stock subject to immediate redemption) may apply to distributions to employees, former employees and beneficiaries if so provided in the plan document, so long as the employer is an S corp or if the corporate charter/bylaws restrict ownership to employees and the ESOP.

Forfeitures of leveraged shares are excludable under IRC section 415©(6) only for a year in which contributions are deductible under section 404(a)(9) .... contributions by a C corporation that are applied by the ESOP to loan payments. That apparently is not applicable in the situation to which you're referring. But if the plan is terminating, why are there forfeitures to reallocate .... as 100% vesting may be applicable. Also, what fiduciary decided to repay the ESOP loan by returning the shares to the employer?