RLL

The plan document provides the rules for eligibility, participation and allocations under the ESOP, so long as such rules do not violate ERISA. But, of course, you knew this. Maybe the plan document can be amended for future plan years. But also look at the stock purchase (and related) documents entered into in connection with the 1042 sale.

Doug --- Are you suggesting that the "necessary documents" be "backdated" ? That's certainly not an appropriate (or legitimate) way to address this problem. It's critical to look at the documentation (including both employer and trustee accounting entries, as well as plan documents and board minutes) in place at the time the employer deposited the funds into the ESOP. What was the trustee told at the time of the deposit(s)? An administrative committee (presumably, an ESOP fiduciary) can't unilaterally decide at year-end (or later) how to characterize amounts previously paid into the ESOP by the employer. I think that there is no easy "fix" here. The employer should get counsel involved at once.

Look at IRC section 267©(4).

My first thought is that someone screwed up here. The entire $1,500,000 (and the remaining 50,000 shares) must be allocated not later than the end of the plan year in which the "deposits" were made. If a dividend (an S corp distribution) was not (or cannot be) declared in an amount sufficient to cover the additional $500,000, the excess amount would be a non-deductible contribution to the ESOP (which must be allocated, subject to section 415 limits), subject to the tax on non-deductible contributions. It may be possible to do some sort of "recharacterization" or refund of the employer "deposits" here, depending on the timing involved and the provisions of the plan documents. I strongly recommend that the employer engage competent, experienced ESOP counsel to explore what alternatives may be available.

Maybe there is no NUA....or maybe the amount of NUA is not significant in relation to the amount that would be taxable if there were not a total rollover.

The 90-day rule is the statutory requirement under IRC section 401(a)(28)(B). But there is nothing that would prohibit provisions in an ESOP plan document allowing participants to make additional diversification elections (beyond the statutory minimum requirements).

Recommendations of specific professionals should not be made through a message board such as this. I suggest that you check with The ESOP Association (www.esopassociation.org), the National Center for Employee Ownership (www.nceo.org) and the Beyster Institute (www.beysterinstitute.org), each of which can recommend qualified, experienced valuation consultants.

The statement by DMZ (on 10/18/05) that "...There may be prohibited transactions if shareholder-employees, their families, or related corporations are selling stock to the plan..." is inaccurate under these circumstances. Merely losing status as an ESOP under IRC section 4975(e)(7) would not cause the plan to cease being a stock bonus plan, which is an "eligible individual account plan" that is permitted to acquire employer stock from parties in interest pursuant to ERISA section 408(e)....so long as the "adequate consideration" requirement of section 3(18) is satisfied.

Hi Leonard --- If the owner is interested in sharing ownership with the other employees, an ESOP should be considered. If the owner is interested in selling all or a portion of his company stock to an ESOP for the benefit of the other employees, an ESOP should be considered. But if neither of these is an objective of the owner, and if the major purpose of the qualified retirement is to fund the owner's personal retirement savings, an ESOP is certainly not the best choice for a company retirement plan.

Under the ESOP regulations, only contributions made to the ESOP for purposes of loan repayment can be used to make payments on the ESOP loan. Assets in the ESOP that are attributable to employer contributions made for other purposes (including contributions made before the ESOP loan was incurred) cannot be so used without resulting in a prohibited transaction under the ESOP loan regs issued by the IRS and DOL in 1977. This appears to be a case of poor planning. If the corporate loan restrictions were in effect at the time the ESOP loan was incurred, neither the company nor the ESOP should have agreed to this loan repayment schedule. If the corporate loan restrictions came into effect at a later date, the ESOP loan terms should have been modified to take into account the limitations on employer contributions. In addition, the company should not have agreed to such corporate loan restrictions without considering the effects on the ESOP and the ESOP loan.

johnpetrancosta --- Please don't take this personally.....but the ESOP "put option," which is provided for in IRC section 409(h)(1)(B), has been a very basic requirement of ESOP law since the 1970s. If you don't even know about the existence of this rule, you really have no business advising anyone regarding an ESOP.

ptpnthr --- Check with The ESOP Association at www.esopassociation.org , the National Center for Employee Ownership at www.nceo.org , and the Beyster Institute at www.beysterinstitute.org .

tfurlong --- Even if the ESOP is obligated to repay the loan balance, only the cash sale proceeds attributable to the loan suspense account shares may be used for such repayment. All sale proceeds attributable to shares which had been allocated to participants' accounts must be allocated to such accounts and cannot be used to repay the ESOP loan. Any amounts paid to the company by the ESOP (to repay the loan balance) will belong to the buyer (assuming that the buyer is acquiring the company and not the assets and business of the company), unless the acquisition documents provide for some other treatment.

Hi nancy --- A stock dividend is treated similar to a stock split. For example, if a shareholder owns 100 shares and receives a 5% stock dividend, the 100 shares have become 105 shares. In your KSOP, the shares received as a stock dividend "follow" the shares with respect to which they are paid. If the suspense account holds 100 shares and a 5% stock dividend is paid, the 100 shares have become 105 shares. The additional 5 shares are added to the suspense account and allocated to participants' accounts as loan payments are made and shares are released from the suspense account.

Hi Kirk --- I think that would raise more serious potential problems with IRS than using separate classes of stock.

MikeD --- Be careful with this. In an extreme case, it is theoretically possible that the IRS could take the position that this arrangement was a sham set up to avoid having to pay non-deductible dividends to the non-ESOP owners (who might be receiving deductible compensation in the form of salaries or bonuses) and/or to avoid application of the section 404(a)(9) and 415© limits on ESOP contributions. Also note that the per share value of the ESOP's stock could be substantially higher than the stock owned by the non-ESOP owners. You'll also have to address now what will happen when the ESOP debt has been fully repaid.

MikeD --- The answer is "yes" if the employer stock owned by the ESOP is common stock. If the stock owned by the ESOP is preferred stock, the stock must be convertible into common stock in order to satisfy the requirements of IRC section 409(l). For purposes of this Q & A, I'm assuming that the company has no class of common stock that is publicly traded.

Alf --- Under IRC section 4975(e)(7), an ESOP must be designed to invest primarily in employer stock which meets the requirements of section 409(l). Non-voting common stock (which is not publicly traded) does not satisfy such requirements. Section 512(e)(3) includes the same requirements for purposes of the exemption from taxation for employer stock in an S corp ESOP. If the S corp "ESOP" to which you are referring holds only non-voting common stock acquired after 1979, it would not be an ESOP under section 4975(e)(7). It still could be a non-ESOP stock bonus plan qualified under section 401(a) and could be a shareholder (subject to UBIT) in an S corporation under section 1361©(6). Becky --- Good question! I now recall that the change in the definition of "qualifying employer securities" for an ESOP under section 4975(e)(7), to require compliance with section 409(l), applied to stock acquired after 1979. But that was a long time ago, and retired minds are sometimes a bit cloudy on such technical issues (some day you may know what I mean). So, non-voting common stock acquired by an ESOP before 1978 (or before 1980) would still be "qualifying employer securities" for purposes of ESOP status under section 4975(e)(7). You are also correct that section 512(e)(3) specifies that only section 409(l) stock qualifies for the UBIT exclusion (the 1978 Act "grandfather" provision is not available to an ESOP for this purpose).

Hi Alf --- It is very clear. Your interpretation of IRC section 512(e)(3) is correct. Only the voting common stock held by an S corp ESOP is exempt from taxation. In addition, an "ESOP" with only non-voting stock does not constitute an "employee stock ownership plan" under section 512(e)(3). It is possible for an S corp ESOP to own some non-voting common stock, so long as the ESOP is invested "primarily" in voting common stock. However, such an ESOP would be subject to taxation with respect to the non-voting stock's share of the S corp taxable income.

I'm very surprised to see that a self-anointed "ESOP Guru" has to come to this message board and ask questions of regular folks.

Special treatment of NUA may not be available to everyone in this situation. NUA attributable to employer stock purchased with employer contributions (including 401(k) elective deferrals) is granted special treatment under IRC section 402(e)(4) only in the case of a "lump sum distribution." A total distribution is a lump sum distribution only if the participant has attained age 59-1/2, died, become disabled or has otherwise separated from service. In the case of the termination of an ESOP, there are likely many participants whose total distributions will not be lump sum distributions under section 402(e)(4)(D). In addition, the exclusion of NUA from the 10% additional tax under section 72(t) may not be available to all participants.

lgolden --- Your ERISA attorney is correct. It is very common for ESOPs to make allocations of company stock to participants' accounts in shares rather than in dollars. In such a situation, there may be no need to use a valuation for the shares in effecting the allocations. Accordingly, an independent appraisal would not be required for that purpose.

It's quite uncommon for an ESOP to allow for monthly installment distributions. Most ESOPs that distribute on an installment basis provide for annual payments. In addition, using the method that stephen outlines would result in the installment payments being made over a four-year period. Distributions over a five-year period, as described in IRC section 409(o)(1)©, would allow for six annual payments, the first of which represents 1/6 of the stock, the second of which represents 1/5 of the remaining shares, etc.

First, you should seek the advice of legal counsel experienced in the design and implementation of ESOPs. The plan documents for the stock bonus plan will have to be amended and/or restated to incorporate the applicable "ESOP requirements" of IRC sections 409 and 4975(e)(7). In addition, an Application for Determination as to ESOP status should be filed with the IRS on Form 5309.

Hi metmer --- For general information about ESOPs, check with The ESOP Association at www.esopassociation.org and the National Center for Employee Ownership at www.nceo.org and the Beyster Institute at www.beysterinstitute.org .