RLL

All shares of company stock in an ESOP, including loan suspense account shares, are assets of the trust and must be included as such on Form 5500. The ESOP loan balance is a liability of the trust, not an asset. The shares are not company debt...they are corporate equity securities. It is likely that the net assets (assets minus liabilities) of the ESOP trust will not be the same as the fair market value of the released (allocated) shares. This is because the fair market value of company stock will usually increase or decrease, and the value of the suspense account shares will be more or less than the loan balance.

The ESOP dividend deduction/reinvestment provision under IRC Sec. 404(k) was included in the Taxpayer Refund and Relief Act of 1999, which was passed by both the House and the Senate early in August. President Clinton has stated that he will veto the tax bill (but not because of this ESOP provision). The IRS regs under IRC Sec. 402 (1.402©-2, Q & A-4) provide that Sec. 404(k) deductible dividend distributions are not "eligible rollover distributions." Such dividend distributions are also exempt from the Sec. 411(a)(11) consent requirement, the Sec. 3405 witholding requirement and the Sec. 72(t) additional tax on early distributions.

The in-service "diversification" distribution is an "eligible rollover distribution" under IRC Sec. 401(a)(31). The 10% additional tax under IRC Sec. 72(t) would apply unless the employee-participant "rolls over" the distribution to an IRA or another eligible retirement plan.

I think that the use of this ESOP Message Board to promote private business ventures in this manner is highly inappropriate and should not be permitted by BenefitsLink.

If you are interested in getting involved as an ESOP service provider, it's very important to learn the special rules, etc., applicable to ESOPs. The more educated and knowledgable about ESOPs that you can be, the less exposure to liabilty. What specific ESOP areas interest you? What services are you thinking about providing? I strongly recommend that you join The ESOP Association, www.esopassociation.org, a national association of ESOP companies and professionals. Also, the National Center for Employee Ownership, www.nceo.org, a non-profit research and educational organization.

The legislative history of ESOPs, going back to 1973, indicates that an ESOP is designed to provide stock ownership interests to employees "substantially in proportion to their relative compensation." In the 1977 ESOP "definition" regs., at Sec. 54.4975-11(e), the IRS took the position that an ESOP could not be combined with a non-ESOP in order to meet the 410(B) and 401(a)(4) requirements. The prohibition against "cross-testing" is just an extension of this historical special nondiscrimination rule for ESOPs, and it appears to reflect Congressional intent relating to ESOPs. If a company wants to utilize the special tax incentives for ESOPs, it must be willing to meet these (and other) more stringent rules.

Check out IRC Sec. 404(a)(9)(A) and Rev. Rul. 76-28.

Contributions made to an ESOP after the close of a taxable year may be treated as having been made on the last day of that year if so designated and if paid by the due date (including extensions) for filing the company's federal tax return. Assuming that the company has a 12/31 taxable year-end and that plan year also ends on 12/31, a contribution made (and used for loan payments) on 2/15/2000 can be treated as a contribution for either 1999 or 2000, as elected by the company. If the company designates the contribution as being for 2000, the appropriate allocation date would be 12/31/2000....unless for some reason the plan document provides for different treatment. You should also review the terms of the loan agreement to determine whether some other treatment of a late loan payment is called for and/or appropriate in these circumstances.

The tax bills now pending in Congress (both the House and Senate versions) would amend IRC Sec. 404(k)(2)(A) to modify the deduction presently permitted for cash dividends that are "passed through" to ESOP participants. The proposed change would extend the deduction to cash dividends on employer stock if the ESOP participants are given elections to either receive the dividends in cash or to have the dividends reinvested in additional employer stock under the ESOP. Present IRC Sec. 404(k)(2)(A) allows the deduction for all dividends on ESOP stock to the extent "passed through" to participants (or their beneficiaries). I don't understand your reference to "just the employee stock account component." There is not necessarily any effect on "ESOP status" where company stock currently makes up 55% of plan assets. The IRC and ERISA definitions provide that an ESOP is designed to invest "primarily" in employer stock. 55% is likely to satisfy the "primarily" requirement. Is the company stock a class that constitutes "employer securities" under IRC Sec. 409(l)? For more information on ESOPs, check the web sites of The National Center for Employee Ownership, www.nceo.org, The ESOP Association, www.esopassociation.org, and Ludwig Goldberg & Krenzel, www.lgklaw.com. (Larry Goldberg, of Ludwig Goldberg & Krenzel is the moderator of this ESOP message board). [This message has been edited by RLL (edited 07-30-99).]

Check with The ESOP Association, www.esopassociation.org, and the National Center for Employee Ownership, www.nceo.org. Both organizations have lists of ESOP professionals who provide administrative services to ESOPs. It's best to use a firm that belongs to both organizations. Membership reflects a commitment to the ESOP area and involvement in "keeping up to date."

1042 tax-deferred treatment is available only to the extent that qualified replacement property ("QRP") is purchased within 12 months after the sale date (or in the 3 months before the sale). The fact that proceeds of the note will be received in a subsequent year does not extend the 12-month period. The seller may use other assets (or borrowed money) to pay for the additional QRP before receiving the note proceeds. The seller may treat the sale as an installment sale. However, the 30% piece represented by the note is not a separate installment sale, but is part of the total sale. If only the cash proceeds are reinvested in QRP, the taxpayer will still have a partially taxable gain in the year of the sale because IRC Sec. 1042(a) provides that gain will be recognized to the extent that the amount realized on the sale (including the portion represented by the note) exceeds the cost of QRP. The portion that is not taxable in the year of the sale can be recognized as taxable gain as the note proceeds are received. The tax computation is a bit complicated.

It's a lot easier to have Company A directly buy the stock of Company B. You'll avoid many technical ESOP issues under the IRC and fiduciary issues under ERISA. You can get the same effect of using "pre-tax" dollars by then having Company A contribute shares of its stock to the ESOP annually (on a non-leveraged basis) equal in value to the amount of acquisition debt you want to "tax shelter." You avoid all the issues relating to leveraged ESOPs, retain greater flexibility in determining annual ESOP contributions, avoid the complication of having the ESOP own stock of two different companies, etc. And you'll still get the same tax benefits for Company A. If Company A is not currently 100% owned by its ESOP, a purchase of Company B by the ESOP, using resources of Company A, would also raise issues with respect to the rights of the non-ESOP Company A shareholders.

YES...The voting rights requirement of former IRC Section 133(B)(7) applies only to a loan with respect to which the lender is claiming the 50% interest exclusion. [This message has been edited by RLL (edited 07-27-99).]

The stock of Company B does not constitute "employer securities" under IRC Sec 409(l) with respect to the Company A's ESOP until both Company A and Company B are at least 80% owned by the ESOP. In addition, if the ESOP were to contribute the Company B stock (which it purchased) to the capital of Company A, it is likely to be a prohibited transaction. There are also many other ESOP and ERISA fiduciary issues to be addressed here. This is a very complicated area of ESOP practice, and it is difficult to provide guidance without knowing much more about the facts and circumstances involved here.

The 1994-96 PLRs are no longer a good source for determining the current position of the IRS. For several years, the IRS has been reconsidering its position on the "primary benefit" requirement of IRC Section 4975(d)(3) in connection with the extension of ESOP loans and has not given rulings on this issue. In addition, fiduciaries should be more concerned about the position of the DOL on the "primary benefit" requirement of ERISA Section 408(B)(3). Apparently, the DOL is taking a more stringent position on this issue than the IRS.

The trustees must determine that the loan extension is primarily for the benefit of participants under ERISA Section 408(B)(3) and solely in the interest of participants under ERISA Section 404(a)(1). In addition, if the primary benefit test under IRC Section 4975(d)(3) is not met, the IRS may impose an excise tax. How does the extension benefit the ESOP participants? Or is the extension primarily for the benefit of the company and shareholders other than the ESOP? What percentage of the company does the ESOP own? It is clear that the extension will result in slower release of shares for allocation to participants' accounts. Is there a problem in amortizing the loan (under its current terms) by reason of the limits under IRC Sections 404(a) and 415? Is the reason for the extension to limit the employer's obligation to make ESOP contributions? For your information, the IRS has an official position that it will not issue private letter rulings regarding compliance with the primary benefit rule of IRC Section 4975(d)(3) in connection with the refinancing and/or extension of an ESOP loan. In addition, the DOL has recently expressed concerns about the actions of fiduciaries in approving extensions of ESOP loans. The two agencies have been discussing how they can reconcile their respective positions under IRC Section 4975(d)(3) and ERISA Section 408(B)(3). [This message has been edited by RLL (edited 07-15-99).]

IRS officials have expressed this view in a number of public forums, including the Annual Conferences of The ESOP Association.

It appears that there may be violations of ERISA Sections 404 (relating to fiduciary duties), 406 (relating to prohibited transactions and fiduciary self-dealing) and 510 (relating to interference with protected rights). An ESOP fiduciary must act solely in the interests of participants and must protect the rights of participants as beneficial shareholders of the company. If the participants are not in a position to hire legal counsel, contacting PWBA is an alternative. On the other hand, it may be preferable to try to find counsel who would be willing to pursue litigation (or the threat thereof) on a cost effective basis. ERISA Section 502(g) does allow a court to award attorney's fees in appropriate situations.

Each participant eligible for the ESOP diversification election under IRC Section 401(a)(28)(B) should be notified during each year's 90-day election period of the amount available for diversification.

It is the position of the IRS that participants who become eligible for the ESOP diversification election under IRC Section 401(a)(28)(B) must be specifically notified regarding the amounts available for diversification and that provisions in the SPD (relating to diversification) are not sufficient for this purpose.

The IRS position (reflected in a TAM) appears to be that Reg. Section 54.4975-7(B) permits the use of elective deferral contributions for payments on an ESOP loan. Several years ago, the DOL requested that IRS change its position....but there is nothing to indicate that IRS has done so. The Reg. allows ESOP loan payments from contributions made for the purpose of repaying the loan. So long as there is appropriate disclosure (under both ERISA and applicable securities laws) to participants that elective contributions are being applied to loan payments, there can be compliance with the ESOP loan regs (both under the IRC and the DOL regs under ERISA). Of course, ERISA Sec 404(a)(1) will still apply to the fiduciary decisions involved, and such use of elective deferrals must be authorized under the plan documents (and specified in the SPD). [This message has been edited by RLL (edited 07-01-99).]

Not unless the ESOP document permits the election for the seventh year.

Babs.....I think you should know that a "do-it-yourself" ESOP can be dangerous to the health and the well-being of you and your company.

A shareholder may sell employer stock to an S corporation ESOP on a tax-free basis if his/her basis in the stock is equal to (or in excess of) the sales price. Such a tax-free sale is not subject to the requirements under IRC Section 1042.