RLL

rocnrols2 - Is Company X a wholly-owned subsidiary of X Holdings that uses its parent company's stock in its ESOP? Do X Holdings and Company X file a consolidated income tax return?

Is this ESOP Message Board now becoming a forum for facilitating the sale of life insurance products?

Hi dmj1998 --- I must admit that stephen's suggestion (to use BenefitsLink) was much better than mine. You are certainly correct that dealing with the IRS website (or...now that I think about it...by telephone, by mail or in person) can be an exercise in futility. I hope I'll do better next time.

Hi gkaley --- In order to be deductible under IRC section 404(k), the payment must be a "dividend" under IRC Subchapter C. Accordingly, it must be paid out of current or accumulated "earnings and profits." Also, it must be a dividend under applicable corporate law.

It is an easy matter to simply amend a 401(k) plan to become an "eligible individual account plan" which is permitted to exceed the 10% limit under ERISA section 407.

Hi dmj1998 --- Try the IRS web site.

IRC section 404(k), which provides for the ESOP dividend deduction, is not a qualification provision to which the remedial amendment rules apply. The rule set forth by IRS in Notice 2002-2 (that a plan must be designated and qualified as an ESOP on the dividend record date) is a reasonable interpretation of the statute. There is no valid reason to allow a 401(k) plan to be retroactively designated as an ESOP for purposes of section 404(k).

That's something that should be requested from competent, experienced ESOP/KSOP counsel who will have the opportunity to review the existing 401(k) plan document(s).

Hi EMozley --- IRC section 409(o)(1)(B) permits an ESOP to provide for the deferral of benefit distributions consisting of leveraged shares until the acquisition loan has been fully repaid (but this exception does not apply to shares that were not acquired with that specific ESOP loan). However, this special ESOP distribution rule is subordinated to the required distribution rules of IRC section 401(a)(9) and (14), which may require distribution of certain amounts prior to the time that an ESOP loan has been fully repaid. This includes any required distributions at age 70-1/2.

jlsilver --- It appears that you'll be treated as having terminated service under the ESOP's vesting provisions. Whether this is legal may depend on the specific terms of the ESOP and the specific details of the "spin off" transaction.

Hi jlsilver --- Is it correct to assume that the ESOP is maintained by the parent company? Is the non-vested portion of your ESOP account being forfeited? Or is it being held for your benefit under the ESOP subject to your completing additional years of vesting service with the "spun off" company? What is the form of the "spin off"......are the shareholders of the parent company going to become the shareholders of the "spun off" company? Or is your company being sold to a third party?

Hi Darrell --- It's nice to know that the IRS agrees with me....even though I frequently disagree with the IRS. For purposes of this ESOP Message Board, it's safe to assume that the IRS is correct when it agrees with me. If the IRS does not agree with me, my position is more likely to be the correct one.

QDROphile --- An investment in closely-held employer stock actually is not "contrary to the 404© regulations," but is available only under extremely limited circumstances. See Reg. Sec. 2550.404c-1(d)(2)(ii)(E)(4)(iii), which denies 404© protection in connection with any transaction (involving employer stock) between the plan and the plan sponsor or an "affiliate" unless certain conditions, including a public market for the stock, are met. The 404© protection specified in the regulations would be available only if the employer stock (that is subject to the participant's investment direction) can be acquired from or sold to a party other than the employer or an "affiliate" of the employer (the definition of "affiliate" for this purpose is fairly broad). This may be possible in some situations involving closely-held companies, but very few.

Hi Kirk --- You are correct with respect to the DOL regulations....whether the statute would provide 404© protection under certain circumstances may be another matter. In this situation, however, there are no participant directed investments into employer stock.

ERISAGuy --- I think 404© protection is available for this arrangement, so long as participants can freely direct the sale of employer stock, but only as to the investments other than employer stock. But in a closely-held company, can such sales really be readily effected? If the sale is to the employer or to another party in interest, ERISA sections 408(e) and 3(18) require an independent appraisal as of the date of each sale.

ERISAGuy --- I think 404© protection is available for this arrangement, so long as participants can freely direct the sale of employer stock, but only with respect to the other investments. But in a closely-held company, can such sales really be readily effected? If the sale is to the employer or to another party in interest, ERISA sections 408(e) and 3(18) require an independent appraisal as of the date of each sale. Jon Chambers --- Your "really quick answer" regarding the use of closely-held company stock is not sound objective advice regarding the ERISA fiduciary rules. With the exception of the "ESOP loan exemption," the ERISA fiduciary provisions that apply to investments in employer stock are very similar for ESOPs and non-ESOP plans which are specifically designed to invest in employer stock. There are thousands of non-ESOP qualified plans which invest successfully in closely-held employer stock. The securities law issues can be dealt with...particularly when employee contributions and investment directions are not permitted with respect to employer stock. Saying that this "should be avoided at any cost" sounds like the pitch of a conventional investment adviser seeking to protect his turf.

Hi QDROphile --- Perhaps it is a bit complicated....but with intelligent application of modern technology, such complications are mere details to be handled by the technicians and their machines. If employers wish to make such flexible 401(k) arrangements (involving investments in company stock) available to their employees and also want to claim the full tax benefits available for employee ownership programs, they'll just have to comply with all the various technical rules (including testing, if required) necessary to achieve their objectives. Obviously, many have elected to do so. Also, many employers have chosen to make "safe harbor" KSOP contributions to avoid any complications involved with ADP testing.

carsca --- Doesn't section 410(B) apply to a 401(k) plan by including all eligible employees as "benefiting under the plan," whether or not they elect to defer, per Reg. Sec. 1.410(B)-3(a)(2)(i) ? If so, each employee who is eligible to defer contributions into the ESOP portion (that is, one who is eligible to elect to invest in company stock, whether or not she/he actually so elects) is treated as "benefiting" under the ESOP.....so 410(B) compliance would not be a problem merely because "separate testing" is required.

carsca --- The temporary holding of contributions in a money market fund pending investment in company stock does not change the fact that participants have directed the investment initially into company stock.....usually it's done prior to the time that the contributions are made. I think that those would constitute contributions to the ESOP portion of the KSOP. I think that the testing should be done on the separate ESOP & non-ESOP portions of the KSOP based upon the extent to which participants have directed the initial investment of each contribution.

carsca --- Cash contributions aren't made to the "non-ESOP" portion of a KSOP if they are made for the purpose of repaying an ESOP loan or if made on behalf of a participant who has directed the initial investment of that contribution into company stock under the ESOP portion. QDROphile --- The ESOP regulations adopted by the IRS in 1977 clearly state that an ESOP may constitute a portion of a plan, the balance of which may be a non-ESOP. The purpose of these provisions, as well as the section 404(k) tax incentive, was to encourage companies to broaden stock ownership among employees. In section 803(h) of the Tax Reform Act of 1976, Congress specifically directed the IRS to promulgate regulations which would expand, and not impede, the creation and operation of ESOPs. The creative use of KSOPs, as endorsed by the IRS, is merely a reflection of continuing Congressional intent regarding employee ownership over the past 28 years.

carsca --- Why should all cash contributions be treated as "non-ESOP" for testing purposes? What if cash contributions are immediately used to buy company stock (per participant elections or otherwise) or to repay an ESOP loan? If cash contributions are initially directed for investment in the company stock fund of the KSOP (and many will stay invested in company stock), how can such contributions be "non-ESOP" for testing purposes?

stephen --- A dividend paid by the employer on company stock owned by an ESOP is not an employer contribution. A dividend is paid equally on all shares of stock (of that class), whether owned by the ESOP or by non-ESOP shareholders. As to the ESOP, the dividend is a return on its investment in company stock....just like interest or dividends on other investments. Dividends are paid as an investment return to all shareholders, while ESOP contributions are paid as deferred compensation to employees. Dividends are properly paid (and allocated under the ESOP) with respect to shares of company stock, not based on participants' compensation. The fact that the highly-compensated employees have larger account balances is usually a result of larger prior allocations of contributions (and forfeitures) over longer periods of time. This is not unlike what happens in most other defined contribution plans...ESOP or non-ESOP. If the HCEs have disproportionately higher balances of company stock as a result of their 401(k) investment elections, it's because they were willing to take the investment risk of non-diversification....and that risk may have paid off. As you know, however, there have been many recent cases of 401(k) participants having elected large investments in company stock which have suffered significant decreases in value over the past two years. And remember that the employer does not get a deduction under IRC section 404(k) merely by paying a dividend on company stock held by the ESOP. The dividend must be used by the ESOP for payments on ESOP debt or must be "passed through" in cash to participants or (under new law) must be either "passed through" or reinvested in company stock at the election of participants. And, if the employer is an S corporation, dividends are not tax-deductible. If the amount of dividends paid (to an ESOP) on company stock is "huge" and truly unreasonable, it is also possible (under certain circumstances) that dividends could be recharacterized as employer contributions.....thereby raising some potentially "sticky" issues under IRC sections 401(a)(4), 404(k) and 415©. Paying dividends on company stock is very different from paying employer contributions to an ESOP. If you're going to call something a "scam," you ought to have better reasons than this one.

carsca --- Right.....

carsca --- The special ESOP forfeiture provision of IRC section 415©(6) is available to a KSOP which includes a leveraged ESOP....but it is not a "rule that the KSOP must comply with." For any leveraged ESOP (including a leveraged KSOP), that provision allows the employer's plan to provide that forfeitures of leveraged shares are allocable without regard to the regular 415© limit (during years when payments are made on ESOP debt) ....if the "1/3 allocation" limit is satisfied. But its use in a particular ESOP is not required.

Carsca --- No.....