RLL

I agree with you that the IRS is wrong.....in fact, the auditor's position is silly. How does sec 482 apply? The interest charged on the loan to the ESOP is a 'wash" with respect to the company.....the company's deduction under sec 404(a)(9)(B) is equal to the company's interest income. If the interest rate were higher, the company would contribute the additional amount and deduct it. It seems that sec 7872(B) would apply (not 482), but only if the interest were at a "below-market" rate. I don't understand your statement that the lower interest rate allows the ESOP to pay off the loan faster. I assume that the company contributes whatever is needed to make scheduled loan payments. The interest on the ESOP "mirror" loan is a "wash" to the company....if the interest were higher, the company would contribute more.

D Crantz --- I hope you weren't relying on the ESOP for your retirement income. Are there assets remaining in the ESOP? Are you entitled to receive benefits? Have you received any account statements? Have you received summary annual reports of the ESOP? Have you requested copies of the ESOP's annual report?

You should check with the California state licensing authority for the appropriate profession for its position on this. There are some states that permit the arrangement which you refer to. Many years ago, the State Bar of California had a position that an employee trust could own stock of a California law corporation only if all trustees and all beneficiaries of the trust were licensed lawyers. This meant that non-professional employees could not participate in an ESOP of the law P.C. I don't know whether this has changed. Note that the IRS non-discrimination regulations (relating to ESOPs) would likely prohibit coverage of only the professionals under an ESOP even if the non-professional employees were covered by a "comparable" non-ESOP qualified plan. But it would be possible to cover the professionals under a (non-ESOP) stock bonus plan, with a comparable profit sharing plan for the non-professionals. By the way, the 1981 Miller case (referred to above) addressed a situation before IRC Section 409(h)(2) permitted involuntary cash distributions in the case of an "ownership restriction."

smm --- In the absence of regulations under Section 409(h)(1)(B), through which the put option requirement was first added to the IRC in 1978, the best guidance for interpreting the put option requirements is the put option provision of the 1977 ESOP loan regs. Section 409(h)(1)(B) extended the requirement to non-leveraged ESOPs.

smm --- Shares which are "restricted" under the securities laws are not "readily tradable." Accordingly, the put option requirement of IRC Section 409(h)(1)(B) would apply to any shares distributed (from the ESOP) which are subject to such a trading limitation. See Reg Section 54.4975-7(B)(10). If this is a problem, can benefit distributions be deferred until the restriction lapses? It is possible that shares distributed from the ESOP to "non-affiliates" may be tradable without regard to the restrictions of SEC Rule 144. Check with SEC counsel on this. If this is the case, the put option requirement would not apply to any such shares.

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

lawdawg --- An ESOP loan must be "primarily" for the benefit of ESOP participants, must be on terms that the ESOP fiduciary determines to satisfy the "arm's-length" standards test, must be for a definite term and must otherwise comply with the 1977 ESOP loan regulations. There is no specific requirement regarding the duration of an ESOP loan....under appropriate circumstances a one-year loan would be acceptable.

AmishKid --- These types of situations are very difficult. I think you need an investment banker/financial adviser to assist in determining the feasibility of an ESOP "rescue" of the company. A lawyer can tell you the rules, but the financial/economic issues are the more critical concerns. Check with the NCEO and The ESOP Association (as referred to by BeckyMiller) for financial advisers with experience in ESOP buyouts of financially-troubled unionized companies.

SDS --- The 15% of deduction limit under IRC Section 404(a)(3) is an aggregate dollar amount based on compensation of employees participating ("benefitting") under either the ESOP or the 401(k) plan. This 15% limit applies to the contributions to the 401(k) plan and the stock bonus plan portion (but not the MPP portion) of the ESOP. If the ESOP is leveraged (and the company is not an S corporation), the special 25% limit under IRC Section 404(a)(9) for contributions used to pay loan principal is based on compensation of employees benefitting under the ESOP alone. If the ESOP is not leveraged (or, if leveraged, the company is an S corporation), there is no specific 25% deduction limit under Section 404(a) applicable to contibutions to the ESOP and 401(k) plan....but IRC Section 404(j) limits the deduction to the amount that can be contributed within the IRC Section 415© limits on annual additions. The 25% deduction limit of IRC Section 404(a)(7) appears to apply only when there is a defined benefit plan and a defined contribution plan.

kredlin --- The only specific provision in the Internal Revenue Code relating to the use of dividends (on employer stock) for payments on an ESOP loan is Section 404(k)(2)(A)(iii), relating to the dividend deduction. Section 404(k)(1) specifically limits the dividend deduction to C corporations, and the IRS has interpretated its 1977 ESOP loan regulations, Sec. 54.4975-7(B), to provide that only dividends on unallocated (loan suspense account) shares may be used for loan payments in the case of an S corporation ESOP. There are many ESOP lawyers who believe that the IRS is misinterpreting its ESOP regulations.

stephen --- Yes....but only if the ESOP plan document so provides.

Hi lawdawg --- An ESOP under IRC Section 4975(e)(7) must be a stock bonus plan under Section 401(a), but it may also include a money purchase plan. If the ESOP includes a MPP, the deduction limit will be increased from 15% to as much as 25% of covered payroll....depending on the money purchase contribution formula....whether or not there is a 401(k) plan, and the 15% and 25% limits available for ESOP contributions are reduced by 401(k) contributions. This rule applies to ESOPs of both C corporations and S corporations. In addition, contributions to a C corporation (but not an S corporation) leveraged ESOP are deductible under Section 404(a)(9) in amounts up to 25% of covered payroll to the extent used to pay ESOP loan principal, with contributions used to pay loan interest being deductible outside of the 25% limit. (This special deduction rule for leveraged ESOPs is available even if the ESOP does not include a MPP). The limitation on annual additions under Section 415© may apply to limit the ESOP contributions below the maximum deductible amount.

Hi JKemp --- Are you the former Bills quarterback and running mate of Bob Dole? An ESOP can be a party to certain types of buy-sell agreements, but it cannot be bound by such an agreement to purchase employer stock at some indefinite time in the future....such as upon the death of a majority shareholder (when it may not be appropriate for the ESOP to make such a purchase).

Under what type of plan was the stock purchased? Was it a 401(k) plan? Was it a Section 423 employee stock purchase plan or other type of stock option plan? Were your husband's payroll deductions on a "pre-tax" or "after-tax" basis? Did the company provide "matching" contributions under the plan? There are different tax consequences depending on what type of plan is involved here.

Hi DDB --- A seller who elects 1042 treatment can still share in the allocation of stock under the ESOP (if he/she is otherwise eligible to so participate), but only with respect to shares that are NOT subject to IRC Section 409(n)....that is, any shares acquired by the ESOP other than in a 1042 transaction. The ESOP's recordkeeper should be separately "tracking" shares which are and are not subject to the Section 409(n) allocation restrictions. Assuming that the 2000 allocation date is 12/31/00, this shareholder can only share in the allocation of any "non-409(n) shares" for 2000 and later years, but he/she cannot share in the allocation of any "409(n) shares."

Relsom --- Getting yourself more education about ESOPs is a great idea! I strongly recommend that you visit both the National Center for Employee Ownership at http://www.nceo.org and The ESOP Association at http://www.esopassociation.org

pax --- If an ESOP is either "frozen" or converted (or merged) into a 401(k) plan, the employer could provide that benefit distributions will be offered to participants. In that event, any such distributions would be "eligible rollover distributions" under IRC Section 402©(4).

Perhaps the ESOP owned preferred stock that was being valued at it's "face" amount, and company/ESOP officials mistakenly believed that preferred stock maintains a constant value. The $100 per share value sure sounds like preferred stock. Or maybe the stock was preferred stock with a variable dividend rate which is adjusted periodically so as to maintain a constant value. In any event, it sounds like this company may now be having serious financial problems.

Hi insurerr --- All or any portion of benefit distributions received in connection with the termination of a tax-qualified ESOP (except for any amount representing the return of after-tax employee contributions) may be "rolled over" (or directly transferred by the trustee, as directed by the participant) on a tax-deferred basis to an individual retirement account ("IRA") or to an employer-sponsored qualified retirement plan (including a 401(k) plan) that accepts such rollovers. The company that is terminating the ESOP is required by law to notify you in writing regarding the options that are available to you.

Hi zvillacorta --- It depends on the circumstances and any applicable provisions of the ESOP documents.

Hi Gibson --- The ESOP is not required to file a Form 1099 to report its stock purchase. The ESOP's stock purchase must be appropriately disclosed on Form 5500. The filing requirements for the 1042 election are the responsibility of the selling shareholder.

Hi TPH --- Under the 1977 ESOP regulations, a loan of more than ten years requires "release" and allocation of shares under the "principal & interest" method. If the loan payments were made as you described, but the "principal only" release method was used, there is a risk that the ESOP loan will be a prohibited transaction and that the ESOP will fail to meet the requirements for "ESOP status" under IRC Section 4975(e)(7)....thus also jeopardizing the status of the first ESOP loan and any special ESOP tax benefits. In addition, assuming that the ESOP plan document includes the appropriate required principal & interest "release" and allocation method, there is the danger of disqualification under IRC Section 401(a) for failure to follow the document in making allocations to participants' accounts. The Section 401(a) violation can be corrected under IRS qualification defect correction programs....but this does not "fix" the ESOP status and prohibited transaction problems retroactively. If there were a "submission" to IRS, the plan sponsor may be faced with PT excise taxes. The loan release and share allocation defects should be corrected to reflect the actual loan prepayments. Correction cannot be effected by the lender's refunding loan payments and the ESOP's refunding employer contributions....there has been no mistake of fact here. The plan sponsor should retain legal counsel with significant experience in fixing ESOP loan and administrative screw-ups and in dealing with the IRS correction programs.

Fred --- Whether or not the plan is an ESOP, the ERISA diversification requirement applies to the investment of assets other than employer stock. An ESOP (or other "eligible individual account plan") is exempt from the ERISA diversification rule only to the extent of investments in employer stock. As I stated above, even if the plan ceases to be an ESOP, it can still be a stock bonus plan which is an "eligible individual account plan" under ERISA.

Hi Fred --- An ESOP must be "designed" to invest primarily in employer stock. A temporary situation where the ESOP has only "about 50% of its assets" in employer will not result in the loss of ESOP status. If this situation will continue for the foreseeable future, it would be best to take some action to assure contination of ESOP status or to plan for the loss of ESOP status. If the plan ceases to be an ESOP under IRC Section 4975(e)(7), it could still be a stock bonus plan under IRC Section 401(a).....except to the extent that the ESOP included a money purchase plan portion. A non-ESOP stock bonus plan can still be an "eligible individual account plan" under ERISA Section 407(d) and, thus, remain exempt from the ERISA diversification requirement to the extent of investments in employer stock. You should think about why the plan is an "ESOP" and whether ESOP status is necessary or whether a non-ESOP stock bonus plan can be used in this situation. If ESOP status must be maintained, it might be appropriate to "spin off" all or a portion of the assets other than employer stock into a new or existing profit sharing plan.

Bristol --- There is no specific limit to the number of loans an ESOP may incur to acquire employer stock....so long as each transaction satisfies the requirements of IRC Section 4975(d)(3) and ERISA Sections 408(B)(3), 408(e) and 404(a)(1). In fact, an ESOP may have multiple loans at the same time.