RLL

No.

Hi Taxman --- Look at IRC section 401(a)(22).

Hi csk --- It's a taxable event. The taxpayer should have considered the possibility of the bond's being called early (a common occurrence for callable bonds) prior to designating it as replacement property.

tcroscut --- An ESOP is required under IRC section 4975(e)(7) to satisfy the requirements of section 401(a), as well as the provisions of section 409(o). Nothing in section 409(o) or elsewhere exempts an ESOP from the requirements of section 401(a)(9) and (14), and compliance with section 401(a)(9) and (14) is not inconsistent with also satisfying section 409(o). Even if an ESOP satisfies the requirements of IRC section 409(o) with respect to benefit distributions, failure of the ESOP to also satisfy the requirements of section 401(a)(9) and (14) would result in the ESOP's failure to be qualified under section 401(a). Finally, with respect to IRC section 401(a)(14), its provisions relating to the payment of benefit distributions are essentially the same as those required for "pension plans" (including an ESOP) under ERISA section 206(a).

ERISA section 408(e) allows a purchase of employer stock by an employer from its 401(k) plan so long as no commission is charged to the plan and the purchase price is not less favorable to the plan than "adequate consideration." ERISA section 3(18)(A) defines "adequate consideration" for a publicly-traded stock based upon the prevailing market price or current bid/asked prices.

Hi mcw --- Banks and other financial institutions (such as savings and loan associations) are subject to special rules under federal and state banking laws and regulations which may prohibit repurchases of their own stock.

Hi dokc --- Do the ESOP plan documents allow the ESOP to buy the shares subject to an exercised put option? Do the documents permit an installment payment for the shares that are put? If so, the ESOP trustee may be permitted or directed to repurchase the shares (subject to ERISA fiduciary rules). If the ESOP distributes all the shares allocated to the participant's account, his account balance becomes zero and he ceases to be an ESOP participant. If the ESOP then repurchases the distributed/put shares in exchange for a cash down payment and a note, the distributee becomes a creditor of the ESOP (the ESOP records a liability for the note payable). The ESOP's note must bear a reasonable rate of interest, should be guaranteed by the employer (ESOP sponsor), and must be secured by a perfected lien on assets of the employer or through guarantee of another party, such as a letter of credit or surety bond paid for by the employer. The general credit of the employer or a pledge of employer stock does not constitute "adequate security" under IRC section 409(h)(5)(B).

KJohnson --- The provision that you cite is intended to require a five-year transitional period (in the case of a non-ESOP that is "converted" to an ESOP) before the ESOP can take advantage of the discretion permitted under IRC section 411(d)(6)©.

KJohnson --- Making any benefit distribution from an ESOP based on a valuation of company stock that is 11 months old is a bad practice and involves many traps for the unwary. There are all sorts of potential issues regarding disclosure, consent, elections, fair valuation formula, fiduciary responsibility, securities laws, etc. Accordingly, many institutional trustees of closely-held company ESOPs will not process benefit distributions based on valuations that are "stale."

SPOT --- The IRS has issued determination letters to numerous ESOPs which include provisions treating such PTE 80-26 loans in the same manner as ESOP stock acquisition loans [under IRC section 4975(d)(3)] for purposes of allocations of stock to participants' accounts.

KJohnson --- (1) IRC sections 409(h)(2)(B)(i) and 411(d)(6)© and ERISA section 204(g)(3) would permit such an amendment to the ESOP. (2) Prohibited Transaction Class Exemption 80-26 permits interest-free loans from the employer to the ESOP for the purpose of funding expenses, including benefit distributions. The IRS has issued determination letters to numerous ESOPs which include provisions treating such loans in the same manner as ESOP stock acquisition loans for purposes of allocations of stock to participants' accounts.

IRC section 401(a)(28)© by its terms requires an independent appraisal of closely-held stock held by an ESOP only "with respect to activities carried on by the plan..." Such activities would include transactions (such as purchases or sales of stock), contributions of stock, and benefit distributions (including diversification); but would not include reporting on Form 5500 or participant account statements. In most cases, forfeitures of stock under an ESOP are reallocated in shares (not dollars) and an independent appraisal would not be required solely for that purpose.

KJohnson --- Reg. section 54.4975-11(d)(5) was adopted in 1977. Section 409(h) was added to the IRC in 1978. Therefore, the "fair valuation formula" requirement of IRC section 409(h)(1)(B) would supersede the 1977 regulation to the extent of any inconsistency. In addition, in connection with a termination of the ESOP (which is the case described in the original question), the fiduciary requirements of ERISA might preclude the trustee from making liquidating distributions to participants at a time when the put option valuation would be eleven months old and possibly not representing current fair market value.

Hi Benefits Brewster --- The election to be an S corporation is not a "reclassification," as it does not involve any change in the rights, preferences and privileges of shares of stock under corporate law. In addition, the election of S corporation status is not a "corporate matter which involves the voting of such shares" within the meaning of IRC section 409(e)(3). The "consent" of shareholders (to the S corporation election) under IRC section 1362(a)(2) does not constitute "voting" of shares under corporate law.

FutureOne --- If the ESOP was not "qualified" in 2002, the financing of the ESOP's stock purchase through the purchase money note may be a prohibited transaction under ERISA. In addition, if the ESOP received a cash contribution in August 2002 (which it used for partial payment for the stock), the contribution is nondeductible if there were no ESOP participants that year. I recommend that you seek the advice of legal counsel experienced in ERISA and ESOP matters in order to resolve these issues.

Hi FutureOne --- For an ESOP to be "qualified" under IRC sections 401(a) and 4975(e)(7), there must be employees who are eligible to participate. It appears that this ESOP was not a "qualified" plan in 2002. What type of transaction resulted in the issuance of the shares to the ESOP? Who sold the shares to the ESOP? Is there an ESOP loan?

Look at IRC section 404(a)(9), which allows a C corporation to deduct contributions used by the ESOP to pay loan interest without regard to the 25% of compensation limit.

Hi Scrappy --- If each of the two employee shareholders continue to own more than 25% of the outstanding shares on any allocation date during the "nonallocation period" defined in IRC section 409(n)(3)©, which is at least 10 years after the sale, they are prohibited from sharing in the allocation of the 1042 shares under the ESOP. This includes the 12/31/01 allocation. Did the two employees pay the same per share price as the ESOP paid for its stock?

Hi lizano --- IRC section 404(k)(5)(B) and Reg. Section 54.4975-11(f)(3).

Hi CJS --- If I were the ESOP trustee, I would not agree to use the ESOP's cash to pay the expenses of terminating the ESOP. Such expenses are being incurred for the convenience of the company (and its "new owners"). In addition, the ESOP trustee should not so easily accept as fact that the ESOP's stock has no value. Were there shareholders other than the ESOP who received some consideration or continuing interest for their stock? Perhaps the ESOP trustee should negotiate to try to obtain some value for the stock.

Hi Kirk --- The general rule of taxation (of qualified plan benefit distributions) is IRC section 402(a), under which distributed property is taxed at its fair market value. See Reg. section 1.402(a)-1(a)(1)(iii). Section 402(e)(4) provides for the exclusion of NUA in the case of certain distributions of employer stock, but the IRC does not address circumstances involving net unrealized depreciation ("NUD"). See Reg. section 1.402(a)-1(b). There is no provision in section 402 (or in section 72) which would impose tax on the cost basis of distributed employer stock to the extent that it exceeds fair market value. ** By the way, how do you like being "mile high" ?

Hi Gruegen --- 1) You are correct except for your last sentence. The $1,000 cash proceeds received from the employer can be rolled over by John, per IRC section 402©(6). To the extent rolled over, there is no current taxation. 2) You are correct. I assume you mean that the ESOP exchanges the shares in Kathy's account for cash (within the ESOP) prior to the distribution.

Hi alliketchum --- What does the ESOP plan document provide? Note that IRC section 409(o)(1)(B) does not supersede the requirements of IRC section 401(a)(9) and (14), which may require that benefit distributions begin prior to the full repayment of the ESOP loan. Also note that ERISA section 206(a) includes a benefit distribution requirement that is similar to IRC section 401(a)(14).

Hi lworthington --- There has been no statutory change to the diversification requirement of IRC section 401(a)(28)(B), and I am unaware of any recent regulatory guidance. The 10-year participation and age 55 rule still applies, and I don't know of anything new regarding the requirement for having at least three investment options for ESOP diversification.

Hi CJS --- How is your post relevant to this topic? The provision of the IRS manual which you've quoted deals with a promissory note provided to an ESOP benefit distributee who "puts" his distributed shares to the company and receives payment over a period of years.