RLL

Of course you can terminate only one portion of a combination plan, including a KSOP! Let's say that you have a combination profit sharing plan/money purchase plan.....nothing would prevent you from terminating the profit sharing portion while continuing the money purchase portion. Likewise, if you have a KSOP which is a combination of a stock bonus plan (the ESOP) and a profit sharing plan (the non-ESOP 401(k) plan), there is no reason why you can't terminate the non-ESOP 401(k) portion while still maintaining the ESOP portion (which then may be terminated at a later date).

In the early or mid-1980's, the SEC ruled that a section 401(k) cash or deferred election (involving an investment in employer stock) with respect to only bonuses would be exempt from registration under the '33 Act. The SEC held that, unlike a 401(k) salary reduction election, there was no "out-of-pocket" investment by participants. This same rationale might apply with respect to the dividend reinvestment feature of a non-contributory ESOP.

Yes....the ESOP portion can have the same (or more liberal) in-service/hardship distributions provisions as the existing 401(k) plan. There appears to be little guidance in the legislative history regarding the frequency of the participant election relating to the dividend reinvestment provision. It likely will be left to the IRS to provide guidance through regulations, which may very well ultimately require quarterly elections. Presumably, the ESOP may provide for the desired default treatment....so long as it is clearly communicated in writing to participants (and beneficiaries) as part of the election process. If dividends are passed through to participants, the existing reporting rules under IRC section 404(k) will apply. Form W-2 would not be used...it would be Form 1099-R or 1099-DIV. The "KSOP" which would result from the addition of an ESOP portion to the 401(k) plan would likely be a combination of two plans....a profit sharing plan (the non-ESOP portion) and a stock bonus plan (the ESOP portion)...under IRC section 401(a). However, the instructions to Form 5500 permit such a combination plan to be the subject of one annual report/return and one audit.

Certain transactions involving non-publicly-traded employer stock require a valuation determination by an independent appraiser as of each transaction date, pursuant to ERISA sections 408(e) and 3(18). The valuation process that you described does not appear to comply with this requirement.

1. Yes. 2. The only real additional "restriction" on ESOP distributions is the right of the participant to receive distribution in company stock (and the right to a "put option" if the stock is not readily tradable). Yes...a participant could elect to transfer funds out of the ESOP if the plan document so provides. It should be easy to comply with the ESOP "diversification" requirement. 3. Reinvested dividends are not contributions. The dividend deduction would be available only if the reinvestment is at the election of the participant. This requires disclosure in connection with the election process.

Won't the $$ limit on 415 annual additions continue to make the 1/3 rule an issue for a C corp leveraged ESOP? Dividends wouldn't be an factor except in an extraordinary situation when the IRS might attempt to "recharacterize" dividends as employer contributions.

Gail S --- The issue is whether the entire KSOP (both the ESOP portion and the 401(k) portion) is designated as an "ESOP" under IRC section 4975(e)(7). Are any elective deferrals being invested in employer stock? Are all matching and any employer discretionary contributions invested in employer stock or do participants direct investment of such contributions? Is there separate testing of ESOP and non-ESOP portions under IRC section 401(k) and (m)? Please better describe the structure of the KSOP....your question can't be answered without more details. And don't believe everything you read in a "treatise".....it may be referring to a different type of arrangement.

The plan is not an ESOP under IRC section 4975(e)(7), as it has not been formally designated as such in the plan document. The designation of the plan as a "KSOP" has no legal significance, as "KSOP" is not a term recognized under the IRC or ERISA. The 5500 has been completed erroneously if it designates the plan as an "ESOP." Dividends on company stock are not deductible under IRC section 404(k). The plan is not subject to the voting rights requirement of IRC section 409(e)(2). Inasmuch as participants have investment discretion over their elective contributions, the plan is an "eligible individual account plan" under ERISA section 407(B) if it expressly provides for investments in company stock beyond the 10% limit. The additional match available for participants who direct investments into company stock may be a testing issue under IRC section 401(m), but it's not a problem under ERISA section 407(B). Enough?

Reg Section 54.4975-11(a)(2) provides that "To be an ESOP, a plan must be formally designated as such in the plan document." It is very common for a non-ESOP stock bonus plan or profit sharing plan to invest more than 10% of its assets in company stock, pursuant to ERISA section 407(B).

In the case of a "publicly-traded" company, the "pass-through" voting requirement under IRC section 409(e)(2) applies only when a plan is designated as an ESOP under section 4975(e)(7) or a tax-credit ESOP under section 409(a). If the "KSOP" of a "publicly-traded" company is a non-ESOP stock bonus plan or profit sharing plan, section 409(e) does not apply....although it is quite common for such a KSOP to provide for a "pass-through" of voting rights to participants (even though it's not required).

It certainly is not uncommon in those situations where the seller is willing to be the lender and/or when bank financing is not available. Inasmuch as a tax-deferred election under IRC section 1042 is not available to the seller of S corporation shares to an ESOP, the complications of combining an installment sale with a tax-deferral election under section 1042 will not arise.

No.

Smokin --- For the latest information on this provision of the tax bill, check the web site of The ESOP Association at http://www.esopassociation.org .

JBeck --- Is it the employer or the ESOP that would be defaulting on the first loan? The consequences of a default would depend on the applicable provisions of the loan documents, the remedies available to the lender(s) and the course of action which the lender(s) chooses to follow.

Smokin --- If the coverage requirements are satified, the S corporation ESOP can be qualified. But note that a provision of the pending tax bill (expected to pass Congress very soon) would add restrictions on the allocations of S corporation stock under an ESOP to certain individuals. For information on this, check the web site of The ESOP Association at http://www.esopassociation.org .

KB --- If the ESOP has received cash contributions (or, perhaps, dividends) made to enable the ESOP to make a loan payment, how does the ESOP fiduciary justify delaying that loan payment and the resulting share allocation to participants? How could such an action be in the best interest (and for the primary benefit) of the participants, as required by ERISA? On the other hand, if the employer is not obligated to make contributions needed for ESOP loan payments and the employer elects to defer such contributions for a year (and defer the year of the tax deduction), then the loan payment and resulting share allocation may be delayed until a subsequent plan year.

Hi Smokin --- Have you been smokin' something? Your scheme won't work. The ESOP doesn't qualify under IRC section 4975(e)(7) if the only covered participant is the former owner. The "ESOP definition" regulations, at section 54.4975-11(e), and the "coverage" regulations, at section 1.410(B)-7©(2), prohibit aggregating an ESOP and a non-ESOP for purposes of satisfying the IRC section 410(B) minimum coverage requirements.

If the provisions of the first loan permit modification of the repayment terms, it might be possible to reduce payments on the first loan in an amount sufficient to allow for minimal payments on the second loan with the total annual share release (and allocation) being the same as currently under the first loan. But the ESOP fiduciary would have to justify that this course of action is "primarily for the benefit" of the ESOP participants. If the employer wants to keep the annual allocations at the same rate, why bother to have the ESOP buy additional stock at this time? Why not just have the employer purchase the shares? The shares can always be transferred to the ESOP at a later date. The proposal for the second ESOP loan seems to complicate matters and raise potentially serious ERISA fiduciary issues. What's the point? What is the employer trying to accomplish here?

No "cutback" problem as there is no effect on participants' accrued benefits. No discrimination issue as there is no favorable treatment for highly compensated employees and all participants are treated in a similar manner.

You don't need a "put option" so long as the employer is willing (and able) to repurchase stock from the ESOP as needed to fund cash distributions. As an alternative, the employer may want to consider making cash contributions to the ESOP to fund the benefit distributions. With regard to the allocation issue, the ESOP can be amended to specify the desired treatment with respect to the cash proceeds received. With appropriate plan language there should be no additional problems.

The basis of the employer stock sold to the ESOP becomes the basis of the qualified replacement property ("QRP"). If there is a sale of any QRP, gain is triggered only on the QRP that is sold.

Hi Kirk --- I don't know what PLR 90-01-035 said. But I do know what IRC section 409(n)(1) says. And according to the stated facts here, those shares were not acquired by the ESOP in a 1042 transaction. The shares lose the 409(n)/1042 "taint" when distributed from the ESOP and then repurchased by the ESOP in a non-1042 transaction. So the selling shareholder can receive his pro-rata share of the allocation of the reacquired stock.

Check with The ESOP Association at http://www.esopassociation.org and the National Center for Employee Ownership at http://www.nceo.org .

No. IRC section 409(n)(1) applies the special allocation restrictions only to "...employer securities acquired by the plan...in a sale to which section 1042 applies..."

Hello Rob Perry !! Ways to avoid or minimize the IRC section 4978 excise tax upon sale of company: * Delay the closing of the sale until 1/12/02....more than three years after the ESOP's stock purchase. * Structure the sale as a tax-free merger or other stock-for-stock exchange, per section 4978(d)(2). * If the ESOP is leveraged, use cash sales proceeds to repay the ESOP loan (with independent fiduciary approval) and take the position that the excise tax is computed only on "net" proceeds. * Were all the shares acquired by the ESOP subject to a section 1042 election?