RLL

The shares are distributed from the ESOP to the distributee and then immediately repurchased by the company. This is not a "put back to the company" .....it's an automatic "call" (redemption) of the shares by the company. If the paperwork is done properly, there is no requirement to issue a stock certificate in the name of the distributee. The ESOP would deliver the distributed shares to the company (or its transfer agent). The shares would then either be held as treasury shares or would revert to the status of authorized but unissued shares (depending on applicable corporate law).

The ESOP is distributing both cash, which is directly rolled over to the IRA, and shares. The distribution of shares (exempt from withholding) is followed by an immediate corporate redemption. The cash proceeds of the redemption (a sale of the shares) are then rolled over to the IRA. The share portion of the distribution (and rollover of the redemption proceeds) does not constitute a direct rollover. It's a rollover of the cash proceeds resulting from the sale of property distributed from the ESOP, per IRC section 402©(6). Seems to me to be OK.

It is clearly inappropriate and illegal for the seller's costs to be paid directly or indirectly by the ESOP. The seller should pay his own costs.

The IRS has routinely permitted such amendments (through the determination letter process) in connection with the termination of ESOPs over the past 20+ years.

I recommend that you seek advice from a lawyer who is experienced in dealing with ESOPs.

The plan document can be amended to eliminate the cash distribution option in connection with the termination of the ESOP, per IRC section 411(d)(6)©, the equivalent provision in Title I of ERISA, and the legislative history under the 1986 Tax Reform Act (which added such provisions to the IRC and ERISA).

The big issue here is complying with Canadian law, which is required if the Canadian employees are to be covered. I haven't looked at this issue for many years, but the Canadian laws at that time were somewhat difficult when investing retirement plan assets in employer stock, particularly if the stock was not publicly traded. But those laws may have been changed.

If there's a 401(k) plan at the company, a transfer of assets to that plan could be used to satisfy a diversification election. Very few ESOPs allow for diversification accounts within the ESOP. Most provide for a distribution or a transfer to a 401(k) plan. Whatever options are to be made available to electing participants must be specifically provided for in the ESOP plan documents, as well as in the SPD. It appears that the plan document you're dealing with here allows for diversification within the ESOP .... bad planning, bad drafting, bad advice. Looks like you'll need plan amendments here. I suggest that you seek advice from competent counsel who has real experience with ESOPs.

A benefit distribution is a "lump sum distribution" if it represents the total amount payable at the time of the payment. A later allocation will not cause the payment to fail to be a lump sum distribution. There are old IRS Revenue Rulings that make this clear. But don't ask me for cites .... you can do your own research.

Cash or stock (of equal value). IRC section 4975(e)(7) .... an ESOP is designed to invest primarily in qualifying employer securities.

The problem with using the appraisal is that it becomes "stale." The year-end valuation does not necessarily represent "fair market value" throughout the year. If the value of the company is rising, KSOP sellers are receiving less than FMV; if value is dropping, KSOP buyers are paying more than FMV. The problem increases with the passage of time. Later in the year the disparity may become significant. Is the company (or any other party in interest) buying shares from, or selling shares to, the KSOP? If so, there may be prohibited transactions resulting from using a stale valuation. What disclosure is being provided to participants? Disclosure of material facts may be required to comply with applicable federal and/or state securities laws. In addition, if participants are acquiring or disposing of shares within the KSOP, the fiduciaries should be disclosing the fact that the appraisal is "as of" the prior year-end valuation date and may no longer represent FMV. The existence of outside trading complicates this situation. Have participants been informed about the outside trading prices for the shares? The changes in trading prices throughout the year may reflect changes in the FMV of the shares from the prior year-end appraisal.

Your approach sounds correct to me. Note, however, that the exclusion of forfeitures under 415©(6) applies only in years when payments are being made on an ESOP loan (when deductions are claimed under 404(a)(9)) and that the exclusion is not available for an S corp ESOP.

IRC section 409(o)(1)© requires a distribution period that is generally "not longer than" five years. A single sum payment would satisfy that requirement.

An ESOP must be designed to invest primarily in stock of the sponsoring employer. An ownership interest in an LLC is not stock.

I'm sure that there are others who accept the interpretation that you are proposing. But the better interpretation, which has been the position of the IRS, is that the son is treated as a more than 25% shareholder and cannot receive allocations of the shares sold by his father. The consequences of violating section 409(n) can be so great that it's not worth the risk of taking your aggressive interpretation. There are other ways to compensate the son without such risk.

Option 1 is fine, but Option 2 is not permissible under IRS rulings. IRS takes the position that the note cannot be rolled over to the IRA. When property is distributed from a plan, either that property or the proceeds from the sale of that property may be rolled over. The note does not constitute "proceeds" of the sale; for this purpose, the IRS says that the installment payments (when and as received) are the "proceeds" of the sale. But most of those "proceeds" will be received after the deadline for completing the rollover and could not be rolled over.

If cash dividends are received by the ESOP during 2006, they must be allocated to participants' accounts by year-end 2006. This applies to the dividends on both allocated and unallocated shares. Crediting any of the cash dividends to a suspense account without any corresponding allocations to participants' accounts is a violation that can result in loss of qualified status under IRC sections 401(a) and 4975(e)(7). If the lawyer who drafted the plan says that "he pulled it from the regs" and cannot provide advice as to what his document means and how it should be applied, you should recommend that the client retain a lawyer who understands ESOPs and knows what he/she is talking about (and understands the documents that he/she drafts for a client). The lawyer's response demonstrates incompetence. It is not the responsibility of the recordkeeper to interpret vague language in the plan document.

If the company puts aside money to cover its future ESOP repurchase obligations, the funds are company assets, not plan assets, and the investment of such funds is not subject to ERISA.

What do the ESOP plan documents and the ESOP loan documents say about this?

IRC section 409(n)(1) provides (in part) as follows: "...no portion of the assets of the plan or cooperative attributable to (or allocable in lieu of) employer securities acquired by the plan or cooperative in a sale to which section 1042 applies may accrue (or be allocated directly or indirectly under any plan of the employer meeting the requirements of section 401(a))..." It appears that the pattern of annually contributing cash to the ESOP for use in annually purchasing stock in a 1042 transaction would result in a violation of section 409(n) to the extent that a portion of that cash is allocated to the shareholder who has elected 1042 treatment. It's clear that section 409(n) was intended to be a broadly interpreted allocation prohibition. Note the statutory language "(or allocable in lieu of)" and "allocated directly or indirectly." The consequences of violating section 409(n) can be so onerous (including plan disqualification) that it's not worth taking risks here.

Why not just obtain the updated valuation in time to process the diversification elections on a timely basis? There are many ESOP companies that are able to complete the valuation process within three months after year-end.

In order for the employer's purchase of stock from the ESOP to be exempt under ERISA section 408(e) and IRC section 4975(d)(13), the purchase price must be not less than "fair market value" as of the purchase date. The ESOP fiduciary responsible for approving the sale of stock by the ESOP should have advice/opinion from its independent appraiser to determine whether there has been any increase in value since the year-end valuation date. If there has been an increase, the fiduciary must determine (based upon an updated appraisal) the updated fair market value as of the purchase date to assure compliance with the "adequate consideration" requirement. An alternative approach to the distributions is for the ESOP to distribute shares to participants and have the employer repurchase the distributed shares at the most recent year-end valuation price.

It is certainly OK to allow for diversification options beyond what is required under the Internal Revenue Code. The ESOP plan document must be amended to allow for the new diversification options that will be made available to the participants. You mentioned that a Corbel ESOP Document is being used. I hope that an experienced lawyer is advising the company with respect to the ESOP. Inasmuch as employee elective deferrals are already being used to purchase employer stock, there is a need to provide sufficient disclosure (regarding the company and its stock) to participants to assure compliance with applicable federal and state securities laws (with respect to the offering of stock). Making available expanded diversification options will involve additional events that may require further securities law disclosures (with respect to the opportunities for participants to sell employer stock). Another concern should be assuring that there will be sufficient liquidity to honor participant requests to diversify out of employer stock, such as matching up buyers and sellers. In addition, close attention should be paid to the valuation of employer stock and the timeliness of the appraisal.

It is inappropriate for this Message Board to be used for direct referrals to individual professionals. The ESOP Association (www.esopassociation.org), the National Center for Employee Ownership (www.nceo.org) and the Beyster Institute (www.beysterinstitute.org) can provide referrals to experienced ESOP lawyers.

The Company B "ESOP" is not a qualified ESOP, without regard to the controlled group issue. An "ESOP" that benefits only the two shareholders who sold their stock to it is a sham....it does not create capital for the company and does not result in a meaningful transfer of ownership. This so-called "ESOP" constitutes an abusive tax shelter. The IRS can (and should) hold such a plan to be non-qualified, per Reg. section 1.401-1(b)(3). It is irresponsible for any professional to advise a client to set up an arrangement such as this.