RLL

BTCISP1969 --- Check out IRC Section 409(n), which imposes strict limitations on the allocation of "1042 shares" to an individual who makes a 1042 election. To the extent that the ESOP allocates shares (or other amounts) which are not covered by Section 409(n), the shareholder might be eligible to participate in the ESOP.

Jim --- The price that the third party investor is willing to pay would seem to be the best evidence of the stock's fair market value. The appraiser must take that price into account in determining fair market value. I assume that the investor would be buying a non-marketable, minority interest, while the ESOP is selling a controlling interest. Accordingly, the ESOP ought to receive a per share selling price that is substantially higher than the price which the investor is willing to pay. Even if an independent fiduciary were to approve the ESOP's sale (and it's hard to believe that such approval could be obtained without the ESOP's receiving a premium price if a truly independent and knowledgable fiduciary were advised of all the facts), the ESOP's sale of stock might still be a prohibited transaction. The fact the employees don't appreciate the ESOP may be a valid reason for terminating the ESOP....but it doesn't permit the purchase of the ESOP's stock at a price below fair market value. The fact that the stock has appreciated in value substantially over the past seven years doesn't eliminate the requirement for the ESOP to obtain a premium price as a condition for selling its controlling interest. In fact, it may be appropriate for the Board of Directors to seek competing offers for the sale of the company at the highest possible price.

amvienna --- 401(k) elective contributions are considered employer contributions for purposes of determining whether there are "substantial and recurring contributions" to a section 401(a) qualified plan, including an ESOP. In addition, there is old IRS guidance holding that a plan can be qualified even if the only contributions are voluntary employee contributions. In your situation, the employer stock acquired with 401(k) salary deferrals is part of the ESOP. Note that the separate testing under the 401(k) rules addresses the ESOP and the non-ESOP portions of the 401(k) plan.

stephen --- The provision of IRC Section 1042 which is addressed by A-2(a)(3) of the temporary regulations was specifically superseded by Section 409(n)(1)(B) in 1986. For purposes of Section 409(n)(1)(B), there is a special rule which provides that shares allocated to a participant under the ESOP are taken into account in determining whether he/she is a 25% shareholder to whom 1042 shares may not be allocated. There is no indication whatsoever in the IRC that the rule in the obsolete regulations is to apply. I agree with you that the proposed interpretation is incorrect. On the other hand, it's always safer to interpret the allocation limitations of Section 409(n) very broadly.....in order to avoid any possibility of the onerous penalties being applied. The "missed" allocation under the ESOP can easily be "made up" to the participant through some form of nonqualified deferred compensation. You should assure that the plan document language and the administrative interpretations thereof are clear as to how this is to be handled.

amvienna --- I don't think the S corporation rules affect any of the issues in this situation.

IRC401 --- Compliance with IRC Section 401(a)(27)(B) is a very simple matter. The money purchase plan portion is designated as such in the plan document, and the profit sharing plan portion is designated as such in the plan document. It just takes two sentences.

stephen --- Obviously, attorneys are sometimes wrong! Why is the ownership an issue? For what purpose is the ownership percentage relevant? It is clear that the ESOP shares (whether allocated or unallocated) are outstanding under state corporate law, including for the purpose of determining voting rights. The individual is not the owner of 100% of the outstanding shares. Why is an IRS private letter ruling relevant in this case? What is the tax issue involved? There actually are circumstances under which ESOP shares would be treated as not outstanding for certain tax purposes. It appears that IRC Section 411(d)(6)(A) would not permit the retroactive amendment to include more participants. Was the 3/31/00 contribution made by reason of a mistake of fact? It must be difficult to deal with a situation where your new client has counsel that is ignorant. But, then, why is it your problem if the client elects to follow the advice of counsel? You shouldn't be liable for these mistaken interpretations of the law if you're directed by the client and its counsel. On the other hand, maybe you should "fire" the client. Life's too short.....

smm --- Unless the documents require the employer to make contributions to the ESOP, why is it "manipulation" if the employer doesn't contribute and the ESOP loan goes into default? If the trustee was concerned, why did it agree to such an arrangement? If you represent a new trustee, why did it agree to serve before getting comfortable with the ESOP loan documentation? When the employer is the lender and the ESOP loan is in default, Section 54.4975-7(B)(6) of the ESOP loan regs provides for a special limitation on the transfer of plan assets to satisfy the default. Maybe the trustee should demand a modification of the documents as a condition of its continuing to serve.

stephen --- Under IRC Section 401(m), all (or a portion of) the employer contributions used to "match" participant elective 401(k) contributions may be made to a money purchase pension plan.

dsilver ---- When a profit sharing plan is combined with a money purchase plan, the combined plan document may be as simple as a money purchase plan document with minor modifications to the employer contribution and allocation provisions.

smm --- The ability of the trustee to sell the ESOP's shares does not in and of itself allow the employer to "manipulate" the loan....unless the trustee is willing to be manipulated by the employer and, thus, to violate ERISA. This should not be a problem if the trustee is acting independently (as ERISA requires). And why should a sale to a third party be limited to a "tender offer?" Any bona fide (and not pre-arranged) sale to an independent third party should be OK, even if it occurs soon after the ESOP's acquisition of the shares, so long as the sale is on favorable terms which result in substantial benefits to the ESOP participants. An independent fiduciary should assure this, and the stock pledge agreement shouldn't restrict the ESOP's ability to do this. What's wrong with the ESOP's having the right to require the employer to buy back collateralized shares....so long as the fiduciary is acting independently on behalf of the ESOP participants?

Kirk --- Reg. Section 54.4975-7(B)(5) limits collateral to the shares of stock. Nothing in the reg addresses issues relating to a sale of stock by the ESOP. Sales proceeds certainly may include "earnings" on the stock, but also include return of the amount invested (the cost)....which clearly is not "earnings." What is also clear is that the 1977 ESOP loan regs are out of date, incomplete, and in need of clarification and updating.

svatty --- This is an extremely complicated area under the IRC. A "gift" or a bargain sale by controlling shareholders to employees or to an ESOP would likely be treated as a compensatory transfer. (See the regs under IRC Section 83). A private foundation could not sell the stock to an ESOP for less than "fair market value." But there may be ways to accomplish what H & W want to do. I recommend that you consult with counsel that's very experienced in ESOP transactions and estate planning.

State corporate law might address the issue as to whether a company is permitted to vote shares of its own stock. The ESOP loan reg doesn't prohibit the voting provision, but the use of "cash and non-cash proceeds" as security for the loan may be a problem.

The instructions to Form 5500 provide that a "pension benefit" plan may include both money purchase and profit sharing components. It is clear that such a combination plan may be accomplished through one plan document. Each component plan must satisfy the applicable requirements of IRC Section 401(a); and separate 5300 Applications would be required (unless the plan is an ESOP which includes a money purchase plan and the Application includes Form 5309).

jw112098 --- In looking at the 75-shareholder limit applicable to S corporations, it is clear (under the Internal Revenue Code) that an ESOP trust is treated as one shareholder. This was confirmed by an IRS private letter ruling in early 1999. There is no limit on the number of participants in an S corporation ESOP. In addition, you should note that the 15% of covered payroll limit on deductible contributions may be increased to as high as 25% when a 401(k) plan is combined with an ESOP that includes a definite contribution formula (in the form of a money purchase plan).

jw112098 --- There certainly are many other 100% ESOP-owned companies that have an ESOP as the only retirement plan. Whether this is a wise policy obviously depends on the facts and circumstances of each particular ESOP company. It is usually up to the board of directors of a company to adopt an additional retirement plan. This is usually done only upon recommendation of the company's management and after consideration of the company's entire compensation and benefits package. You are correct in your concerns regarding retirement security.....if the value of company stock diminishes, the value of your allocable share of the ESOP's company stock will be reduced. If company stock becomes worthless, your ESOP benefits will become worthless (except to the extent that the ESOP has "other investments" or that you have exercised your ESOP "diversification" rights). In the event of bankruptcy, it is unlikely that company creditors will be very concerned about the value of your ESOP benefits (or lack thereof). Have you expressed your concerns to management ...preferably through the human resources department? Have you asked about the possibility of establishing a 401(k) plan? It is possible for an ESOP to be designed to allow for total tax-deductible contributions (by the company and the participants) to a 401(k) plan and the ESOP in amounts up to 25% of covered payroll....even in an "S" corporation. It is also possible for a 401(k) plan to allow for only employee elective contributions and no company contributions. Perhaps these approaches should be addressed with appropriate decision-makers at the company.

Under IRC Section 401(B) and the regulations thereunder, an Application for Determination should be filed by the due date (including any extension) for filing the plan sponsor's federal income tax return for the taxable year in which the plan is first adopted or for which any amendment is intended to be applicable. In some situations, tax legislation (which affects the applicable qualification requirements) or IRS regulations relating thereto will provide for a later date for amending plans and/or filing Applications for Determination.

The payment by the company is not a distribution from the ESOP; it is an installment payment for the purchase of the stock. As such, it is not subject to withholding.

The Plan Administrator is the party responsible for ERISA reporting and disclosure requirements, such as preparing and filing the 5500, preparing and distributing SPDs, SMMs and SARs, etc. These are responsibilities best allocated to the employer, not the Trustee and not any employee.

What kind of help do you need? Legal? Administrative? Consulting? Financial? Communications? Valuation? Is there an intent to use 401(k) elective deferrals for the purchase of company stock? If so, there may be a requirement for registration under applicable federal and state securities laws. You definitely should retain a lawyer with extensive experience in designing ESOPs, advising on ESOP administration and structuring ESOP transactions. I recommend that you start by contacting The ESOP Association (www.esopassociation.org) and the National Center for Employee Ownership (www.nceo.org).

QDROphile --- Please explain why you believe that "It is almost never a good idea for the employer to be the plan administrator." The functions of the "plan administrator" under ERISA Section 3(16)(A) and IRC Section 414(g) seem to involve matters that are best taken care of by the employer. Indemnification is of little value if the employer were to become bankrupt. Even when an employee is indemnified, being a defendant in litigation, or the target of an IRS audit or DOL investigation, is not fun. Why not let the employer take the responsibility and potential liability?

It would be permissible under the Internal Revenue Code, but....what does the ESOP plan document provide?....what is the ESOP's benefit distribution policy?

Jim --- The seven-year limit under former IRC Section 133 will no longer apply. The loan may be extended, subject to IRC Section 4975(d)(3) and ERISA Sections 404(a)(1) and 408(B)(3). It would be advisable for the ESOP's agreement (to extend the loan term) to be made by an independent fiduciary.

Jim --- The prior discussion was limited to the voting rights requirement under former Section 133(B)(7) of the IRC. Refinancing of an ESOP loan is subject to the "primary benefit" requirement of IRC Section 4975(d)(3) and ERISA Section 408(B)(3), as well as the general fiduciary rules of ERISA Section 404(a)(1). Acceptable terms for refinancing of an ESOP loan depend on facts and circumstances.