RLL

gkaley --- Cash is cash. A cash contribution of $50 in June results in $50 of annual additions when allocated to participants' accounts in December. It doesn't matter (for purposes of Section 415) how the $50 is invested during the June-December period. In determining annual additions, you count the $50 cash contribution not the stock purchased (with the $50) and allocated to participants' accounts.

gkaley--- Good question! Surprisingly, the answer is "yes"...there is a $50 annual addition. See Reg. Sec. 1.415-6(B)(4).

Hi gkaley --- Annual additions under IRC Section 415© for all defined contribution plans [including ESOPs] are based on the actual amount of cash contributed or the value of property (including company stock) contributed, determined as of the contribution date. To the extent that there are earnings on contributions (or the value of a contribution in property has changed) as of the allocation date, the difference represents investment income (or loss). Any such investment income (or loss) must be allocated to participants' accounts in accordance with the terms of the plan documents, and the amounts so allocated (as investment income) are not annual additions under Section 415©.

Hi kredlin --- IRC Section 1372(B) defines 2% shareholder by reference to Section 318 attribution rules. Section 318(a)(2)(B)(i) provides that stock held by a Section 401(a) employees' trust [that would include an ESOP] is not treated as owned by the beneficiaries. Accordingly, company stock allocated to a participant under an ESOP is not treated as owned by that individual for purposes of the 2% shareholder rule of Section 1372.

CRC --- You can utilize one of the IRS "correction" programs to cure the qualification defect resulting from failure to comply with the 90 day/90 day requirement of IRC Section 401(a)(28)(B)(ii).

Contributions to an ESOP that includes a money purchase plan combined with a stock bonus plan are subject to a deduction limit of 25% of covered payroll....this 25% limit is available to both C corporations and S corporations. If the ESOP does not include a money purchase plan, the general deduction limit is 15% of covered payroll (unless "credit carryovers" from pre-1987 years are available). The special deduction limit applicable to contributions used for ESOP loan payments, under IRC Section 404(a)(9), is available only to C corporations. In an ESOP of a controlled group of corporations, the deduction limit applicable to any S corporation (together with any qualified S corporation subsidiaries) would be computed separately, based on the covered payroll of its employees, and any S corporation could not utilize Section 404(a)(9).

IRC401 --- Section 54.4975-11(a)(5) of the 1977 IRS regulations under IRC Section 4975(e)(7), defining "employee stock ownership plan," provides as follows: "(5) Addition to other plan. An ESOP may form a portion of a plan the balance of which includes a qualified pension, profit-sharing, or stock bonus plan which is not an ESOP. A reference to an ESOP includes an ESOP that forms a portion of another plan." This makes it very clear that an ESOP may be a portion of a combination plan that includes a non-ESOP portion.

If the 401(k) portion is a profit sharing plan, it is not subject to IRC Section 409(e). If the 401(k) portion is a non-ESOP stock bonus plan and the employer has stock that is publicly-traded, it is not subject to section 409(e). If the 401(k) portion is an ESOP or a non-ESOP stock bonus plan and the employer does not have stock that is publicly-traded and more than 10% of the plan assets are securities of the employer, it IS subject to the Section 409(e) voting rights requirements by reason of Section 401(a)(22). Why would you want to deny employees voting rights on shares of company stock purchased with their own 401(k) contributions....especially when they have certain voting rights on stock in the non-401(k) part of the ESOP?

If the employer has no stock that is publicly-traded, the ESOP is subject to IRC Section 409(e) by reason of Section 401(a)(22)....which is a qualification requirement. Non-compliance under these circumstances would jeopardize the qualified status of the ESOP under IRC Section 401(a)....but this does not jeopardize the "validity" of the entire plan as an employee benefit plan under ERISA. If the employer has stock that is publicly traded, the ESOP is subject to Section 409(e) by reason of Section 4975(e)(7), which is the "ESOP" definition, and not by reason of a Section 401(a) qualification requirement. Note that there are several IRS programs which now allow for the "correction" of Section 401(a) qualification defects.

If the 401(k) portion of the plan is an ESOP under IRC Section 4975(e)(7) (and is not a non-ESOP part of an ESOP), it is subject to the requirements of IRC Section 409(e).

Are you saying that you cannot complete the process within 180 days after year-end, as required by IRC Section 401(a)(28)(B)(ii) ? Why not just get the valuation completed earlier ?

At a minimum, you'll need a valuation by an independent appraiser as of the date the employer purchases company stock from the ESOP in order to comply with ERISA Sections 3(18)(B) and 408(e). In order to comply with ERISA Section 404(a)(1), there should be an independent fiduciary for the ESOP.

The answer to your question depends upon the manner in which the termination of the ESOP will be effected. Will the benefit distributions be made from the ESOP in shares of company stock or in cash? Is the employer prepared to provide "put options" to the distributees? Or does the employer intend to repurchase shares from the ESOP in connection with the termination? Are there any "material" events which are likely to have affected the value of company stock since 12/31/99? Is there an independent fiduciary for the ESOP?

PJK---- I never said (and do not believe) that membership in the NCEO or The ESOP Association (or any other professional organization) makes someone an expert. You were the one who first brought up that issue in your posting this morning. Memberships in both the NCEO and The ESOP Association demonstrate a professional interest in, and commitment to, the field of ESOPs and employee ownership. There is no better way for an ESOP professional to network and keep up with current developments and innovations in ESOPs. It's clear from this thread that you have not had that benefit.

PJK--- As a longtime member of both the American Bar Association and the State Bar of California, I certainly can say that membership in these two organizations does not make me (or any other member) an "expert" in any subject. It takes a lot more than membership in a professional organization (and passing membership exams, if required) to be an "expert." Very few members of the ABA or the State Bar are true experts in their fields, including employee benefits; and very few employee benefits experts can be considered experts in ESOPs and employee ownership. If I did have a professional interest in the work of SCEBS/IFEBP or CPC/ASPA, I am certain that I too could pass their entrance exams. But that alone would not make me an expert.

PJK--- Reinvestment in company stock at the time a distribution is payable would be needed only when that distribution is actually going to be made in shares of company stock....which is often not the case in a closely-held company ESOP (even when the Section 409(h)(2)(B) exceptions are not applicable). Including the necessary language in an ESOP plan document is a very simple matter for an experienced draftsman. It's obvious from reading your postings here (and seeing your listing of current professional memberships) that ESOPs are not an important part of your professional practice.....so membership in the NCEO or The ESOP Association (and the networking opportunities they provide) would not be significant for you. My involvement in these organizations does not make me an expert, just as membership in your professional organizations does not make you an expert in anything. Pay your dues and you can become a member of many of these groups. But active membership in the NCEO and in The ESOP Association does reflect a professional interest in (and commitment to) the subject and a desire to keep current on what's happening in the real world of ESOPs and employee ownership.

Yes. Nothing in IRC Section 404(k) would deny the deduction for "passing through" dividends on unallocated shares to the ESOP participants. The ESOP would have to include provisions allowing for such "pass through" and for the allocation of such dividends to participants on a nondiscriminatory basis.

The Profit Sharing Plan should have gotten its pro-rata share of any proceeds payable to the shareholders when the corporation was liquidated. If there were no proceeds payable to the shareholders, the stock owned by the Plan became worthless and should be written off as a total loss.

PJK--- I think that my various posted messages on 8/2/00 made it clear that any ESOP (which so provides) can "disinvest" the accounts of all former employees, even an ESOP which permits participants to demand benefit distributions in the form of company stock. I really don't understand your concerns about this. Are you actively involved on an ongoing basis in working with ESOPs ("employee stock ownership plans") in closely-held companies? You aren't interested enough in ESOPs to be a member of the NCEO or The ESOP Association. To my knowledge, you don't attend any of the many NCEO or ESOP Association conferences; you don't publish articles about ESOPs. Your postings here have demonstrated a misunderstanding of many of the special technical rules that apply to ESOPs. Are you at all "plugged into" the real world of closely-held company ESOPs or are you just speculating here? I do know, both from first-hand experience and from networking with many other experienced ESOP professionals, that many closely-held companies want to limit ownership (and beneficial ownership) of company stock to CURRENT employees. And many of those companies "disinvest" the ESOP accounts of former employees out of company stock after termination of service. The law permits it. And if a particular ESOP company wants to utilize this feature in the design of its ESOP, why not? An ESOP is not the same as direct ownership of stock. There are a number of incidents of stock ownership that are not required to be provided to ESOP participants. An ESOP provides a limited form of beneficial ownership to current employees. Employees who participate in a closely-held company ESOP usually understand and accept the differences between an ESOP and direct ownership of company stock. An ESOP participant is entitled by right to all the benefits provided for under the terms of the ESOP and under applicable law, but not more than that. I think it's very good when an ESOP company opts to include features that make ESOP participation more like direct ownership of company stock. But that's a choice of the company, after considering all the alternatives available in the design of an ESOP....it's not something that should be determined by the personal preferences of professional advisers. [Edited by RLL on 08-13-2000 at 01:44 PM]

The Bulletin Board ("BB") is a quotation system sponsored by a national securities association (NASD)....so it appears that a stock listed on the BB would be "publicly-traded" under the 1977 ESOP loan regulations. Note, however, that the "put option" provisions of those regulations have likely been superseded, in part, by the put option requirement of IRC Section 409(h)(1)(B), added to the IRC by the Revenue Act of 1978, for stock acquired by an ESOP after 1979. Section 409(h)(1)(B) uses the term "readily tradable on an established market" (rather than "publicly-traded") in referring to stock which is subject to the put option requirement. It is not so clear that these terms will be interpreted precisely the same by the IRS. I believe that there was a PLR or Rev. Rul. published by IRS in the early to mid-1990's that may have addressed this issue.

PJK --- I think that the existence of many IRS determination letters on ESOP deferral/disinvestment provisions is significant evidence of their legality. The legal concerns that you have raised all seem to be qualification issues under IRC Section 401(a) and related requirements. A determination letter from the IRS as to a specific ESOP is certainly sufficient assurance for that employer to proceed with the implementation of these provisions. With regard to aligning the interests of employees with those of shareholders, I seriously doubt that the "disinvestment" of former employees creates a problem. In closely-held company ESOPs, it is an extraordinary event for a participant to demand a benefit distribution in the form of company stock...most participants clearly want benefits in cash. When benefits are distributed in stock, almost all distributees exercise their put options to receive cash. There are also an increasing number of ESOPs that rely on the "ownership restriction" or S corporation exceptions of IRC Section 409(h)(2)(B). The inclusion of the put option requirement in Section 409(h)(1)(B) was to assure that participants could "cash out" their closely-held company stock to provide retirement benefits. The purpose of "employee ownership" through ESOPs is to provide beneficial ownership of company stock to CURRENT employees, not former employees. Very few closely-held companies want former employees as shareholders....including employees who have terminated service by reason of retirement....and very few former employees want to own stock in their former employer if the company is closely-held. Also, an ESOP by design generally defers most benefit distributions until after termination of service. If ESOPs were going to provide full incidents of stock ownership to the participating employees, there would be provisions for participant elections for full in-service distributions; there would be full voting "pass-through" rights for participants; and there would be full dividend "pass-through" rights. I certainly don't oppose many of these features, but the law doesn't require them and most ESOPs don't include them. I am not the one who has misinterpreted IRC Section 409(o). Section 409(o)(1)(A)(ii) clearly permits an ESOP to provide for a deferral of distributions for a period of up to six years following termination of service for reasons other than retirement, disability or death.....subject to Section 401(a)(9) and (14), if applicable. The participant election in Section 409(o)(1)(A), to which you refer, relates to a participant election to further defer distribution, such as under Section 411(a)(11). Section 409(o)(1)(A) permits an ESOP to defer distributions [but not as long as is permitted for other qualified plans under Section 401(a)(14)] and does NOT require a participant election for an immediate distribution. Have you read the Senate Finance Committee report under the Tax Reform Act of 1986 relating to this provision? Have you checked the BNA Tax Management portfolio on ESOPs (to which you previously referred)? What's the authority for your position (which is certainly contrary to that stated by most ESOP professionals and literature)? Regarding my so-called "non-disclosure" of a material plan provision, I incorrectly assumed that folks with such significant ESOP experience would understand what I meant when I referred to those provisions that you think are so unique. I believe that an experienced practitioner should be aware of ALL the various options for ESOP plan design that are available under the law (even if he/she is not aware that many ESOPs are utilizing such features). Perhaps you should request sanctions against me under BenefitsLink's equivalent of SEC Rule 10b-5. And why are you not a member of The ESOP Association or the NCEO if you have such an long-term intense interest in ESOPs and employee ownership? [Edited by RLL on 08-07-2000 at 11:19 PM]

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

PJK --- What a coincidence! The NCEO E-Mail Bulletin for August 2000 (sent on 8/3/00) includes a reference to an article (dated May/June 2000) on the NCEO web site entitled "Converting ESOP Stock to Other Investments for Former Employees." See http://www.nceo.org/columns/news20.html The article says, in part, that "it is increasingly common for ESOPs to provide that employees who terminate before death, retirement, or disability have their account balances transferred out of stock into other investments until a distribution is actually made. To discourage people from leaving just to cash out, however, distributions are often deferred, often to the legal limit. Companies can have tiers in their plan, providing that only accounts over a certain balance will be treated this way." Apparently, RLL is not the only person who has found such a feature to be common in ESOPs of closely-held companies. With your obvious interest in ESOPs, you might want to join the NCEO and The ESOP Association in order to better keep current on what's actually happening in the ESOP world. [Edited by RLL on 08-04-2000 at 02:23 PM]

PJK ---- The objective of EMPLOYEE ownership is not really accomplished by providing company stock to FORMER employees...it is better done by providing greater stock ownership interests to CURRENT employees...those whose efforts can still affect shareholder value. This is one of the reasons that the "ownership restriction" exception was added to IRC Section 409(h)(2) in 1981. There is no reason for me to defend the practice of deferring ESOP benefit distributions following termination of service. The issue raised in this thread was whether "disinvestment" during the deferral period was a violation of the "consent" requirement of IRC Section 411(a)(11). It appears that you no longer disagree with my position on that. Just because it's legal to defer ESOP benefit distributions doesn't make it the right thing to do. But if an employer wants to have such a deferral provision in its ESOP, after carefully considering all of these issues, why not? I'm not necessarily recommending it as good plan design and/or policy, but I can certainly support the legality of the provision. Also, many ESOPs which include such deferral provisions use a deferral period of less than six years. Note that the six-year deferral period comes right out of IRC Section 409(o)...a clear reflection of Congressional intent to permit such a deferral period (as you know, the law allows non-ESOP retirement plans to defer to retirement age). Once a plan design decision has been made to defer the ESOP benefit distributions (which may or may not be a good policy decision), I think it's very consistent with ESOP objectives to "disinvest" the former employees and shift additional stock ownership to the current employees. Your reference to the BNA Tax Management portfolio model is interesting, but it's only one model and doesn't reflect the world of closely-held company ESOPs as I know it. Have you checked the model ESOP of the National Center for Employee Ownership (NCEO)? I wonder what provisions it includes? What about other models? Maybe we should ask the NCEO or The ESOP Association to poll their closely-held ESOP company members as to their distribution practices! As you may have noticed, BenefitsLink has made this thread a feature in its daily newsletter and on the Benefits Buzz page. Do you think this is a "particularly interesting" subject? Don't we each have better things to do with our time? Does anyone else care about this?

PJK ---- It's very common for ESOPs of closely-held companies to defer the distribution of benefits for periods of one to six years following termination of service. The purpose of the "disinvestment" is to shift the potential appreciation in value of company stock from former employees to current employees...clearly reflecting the objective of employee ownership. One reason that some companies decide to defer benefit distributions is to eliminate the "problem" of employees quitting "to get the money." I question whether this is good policy in light of today's job environment, but it's important to many ESOP companies. Another reason to defer benefit distributions is to allow for better management of the ESOP "repurchase" obligation. But in this situation, "disinvestment" is unlikely (as liquidity is probably limited). Where a KSOP is involved, deferral of benefit distributions is usually limited to the account balance(s) attributable to company contributions.