RLL

gmann --- If this is going to be an ESOP covering "only two family member employees," it is the type of scheme that Congress appropriately found to be abusive and not entitled to tax-favored treatment. ESOPs are intended to provide broad-based stock ownership for employees. What you're describing is using ESOP as an abusive tax-shelter, not as an ownership sharing employee benefit plan.

Hi IRC401 --- I think that the valuation issue is separate from the financing issue. The employer is providing the financing to the ESOP and will also provide the ESOP with the funds needed to repay the loan. It seems to be in the best interests of both the employer and the ESOP participants to have the loan at the lowest possible interest rate. But using a below-market-rate of interest would, in fact, just be a way to circumvent the 25% of pay deduction limit under IRC section 404(a)(3). I see no ERISA issue here.

Hi Kirk --- stephen said in his original post that "[t]he issue is 404 deduction limit and having no interest would be helpful." I implied from that statement that the section 404(a)(9)(B) deduction (for contributions used to pay interest on an ESOP loan) is not available.....maybe the employer is an S corporation. Under such circumstances, the imputing of interest could affect the ability to amortize the ESOP loan with deductible contributions. As you know, having a leveraged ESOP in an S corporation has become very common in recent years.

Hi DeePA --- If the deceased owner was a more-than-25% shareholder when the 1042 sale occurred, his/her sons are treated as more-than-25% shareholders under IRC sections 318(a) and 409(n)(1). A more-than-25% shareholder cannot receive an allocation of any of the 1042 sale shares, and the nonallocation period under section 409(n)(1)(A) does not apply to allow allocations to such shareholders even after ten years. See section 409(n)(1)(B). The death of the seller does not effect any change in this rule.

stephen --- In the case of a below-market rate of interest loan, the IRS should "impute" interest under the related party loan rules and under the section 415© regulations.

blaum8 --- Does the promissory note specify how prepayments are to be applied (to the next installment of principal or to the last installment) ? Is the plan sponsor obligated under the terms of the loan documents or the ESOP plan documents to make contributions needed to make loan payments? Is the plan sponsor the lender or is it a third party? The shares released (from the suspense account) by reason of the prepayment MUST be allocated to participants' accounts in the manner provided in the ESOP plan documents for the allocation of shares released by reason of a dividend on employer stock. Note that only dividends on shares acquired with the proceeds of that loan may be used for loan payments; and, if the plan sponsor is an S corporation, dividends on any allocated shares may not be used for loan payments. If the payment to the ESOP by the employer was truly a dividend (and not a disguised contribution), the allocation of the shares released by reason of the loan prepayment does not result in annual additions under IRC section 415©. If the employer is not an S corporation, the dividend may be deductible under IRC section 404(k). You've got a situation here with many potential problems. Kirk's recommendation should be followed.

In a closely-held company ESOP, such a provision would accelerate the repurchase obligation.

amboyd --- An ESOP may provide for in-service distributions upon attainment of age 59-1/2. Only tax credit ESOPs (TRASOPs and PAYSOPs) must comply with the 84-month rule.

Hi ladler --- If shares from electing participants' ESOP accounts are sold to satisfy their diversification elections, the total amount due to those participants is the net sales proceeds (after commissions). Such proceeds would be allocated among the participants in proportion to the number of shares sold from each account. Why not have the ESOP distribute the shares and let the participants sell?

Hi Babs --- Under ERISA sections 408(e) and 3(18), the purchase price paid by the ESOP may not exceed "adequate consideration" (appraised fair market value, in the case of a closely held company) on the purchase date (the date the ESOP acquires ownership of the shares). It is quite common for ESOP fiduciaries to receive updated valuation opinions on (and as of) the date that an ESOP transaction closes....experienced ESOP appraisers/financial advisers have no real problem in doing this. Making a sale "effective" as of a prior date is irrelevant for this purpose. The applicable date for determining compliance with the "adequate consideration" requirement is the date of the ownership transfer. There is no problem under ERISA if the purchase price paid by the ESOP is less than "fair market value"....ESOP fiduciaries are supposed to negotiate for the lowest possible purchase price.

GBMcGrath --- Treating an LLC as a corporation for tax purposes does not change its ownership interests to stock. Furthermore, even if the IRC were to treat LLC interests as stock, ERISA section 407(d)(5) would not treat the LLC ownership interests as stock....so an ESOP could not own such LLC ownership interests.

Hi GBMcGrath --- Employer securities for purposes of funding an ESOP must be "stock," per IRC section 409(l). Also, see ERISA section 407(d)(5)(A). An ownership interest in an LLC is not stock....only corporations issue stock to represent ownership interests. Accordingly, an LLC cannot issue stock which would constitute "employer securities" under the IRC or ERISA.

mab --- Look at www.esopassociation.org. Also, check out the Beyster Institute www.beysterinstitute.org .

yes

Hi ptpnthr --- I think that the IRS feels cold and slimy.

Hi ptpnthr --- It appears that the NUA exclusion in such a situation would only be available to participants who have attained age 59-1/2 or are disabled, as well as for death benefits attributable to participants who had attained age 59-1/2 or had become disabled prior to death. Note the language of IRC section 402(e)(4)(D)(i) --- "after" is used for the age and disability situations, while "on account of" is used for death and separation from service. Plan termination is not in and of itself an event which triggers availability of the NUA exclusion.

Hi John --- If the ESOP acquired (paid for) the shares at a controlling interest price, the shares should continue to be valued on that basis .... otherwise the participants would not receive benefits which reflect the "control" that the ESOP used trust assets to pay for. Remember that ERISA section 404(a)(1) requires fiduciaries to use ESOP assets "solely for the purpose of providing benefits....." If the ESOP's "control" block of shares was acquired at minority interest price(s), the shares may continue to be valued by the fiduciaries on that basis for the purpose of determining individual participants' benefits. This is what happened in the U.S. News case.....the profit sharing plan there never paid controlling interest prices for the shares it acquired.

Hi beth --- The opinion of the valuation firm that it doesn't have a conflict sounds like the major investment banking firms' saying there's no conflict when the investment research people are generating investment banking business from the companies they are rating. Ask NY AG Elliot Spitzer about that. Your situation involves an ESOP which is not represented by an independent fiduciary. It appears that there is a possibility that the ESOP may be treated differently from the majority shareholder (who also happens to be an ESOP trustee). The big "fairness" issue here is the different treatment of the ESOP. Under these circumstances, I would strongly recommend retaining an independent fiduciary to represent (and negotiate on behalf of) the ESOP in this transaction. Alternatively, you should have the majority shareholder resign as an ESOP trustee and have the two remaining trustees (I assume that they aren't related to the majority shareholder....hopefully, they can demonstrate that they're acting independently) retain legal counsel and a financial adviser (that are truly independent of the majority shareholder) to assist in negotiating the terms of the merger on behalf of the ESOP. The situations in which DOL objected to multiple representation by a valuation firm involved investigations and litigation.

Hi ladycpa --- It would be difficult to say that there has been a "reinvestment" prior to the time that funds representing the dividend payment have actually been used to acquire employer stock for the electing participants.

Hi beth --- If there is a possibility that the ESOP and the majority shareholders may be treated differently in the merger, there is clearly a conflict of interest for the valuation firm to represent both. How can one firm represent both sides in the negotiation as to the merger consideration to be received by the various parties? The valuation firm ceases to be "truly independent" when it is retained by the majority shareholders. What's the objection to having the ESOP independently represented? Is there an independent fiduciary for the ESOP? I do know of several merger situations involving ESOPs in which the DOL objected to multiple representation by the valuation firm.

Hi SRH --- No.....For purposes of IRC section 401, all employees of all members of a controlled group of corporations are treated as employed by a single employer, per section 414(B).

Hi walker --- Yes....so long as the plan document(s) provide that the trustee is to be directed by the committee with respect to investment decisions.

Hi Troubles --- The ESOP diversification requirement of IRC section 401(a)(28) applies only to stock acquired by an ESOP after 1986. Is it possible that your company's ESOP has not acquired any additional shares of stock after 1986? Also, the diversification rule applies only to "statutory" ESOPs, as defined in IRC section 409(a) or 4975(e)(7). Is it possible that your company's "ESOP" is actually a stock bonus plan that is not a statutory ESOP?

Yes.

Alan --- The ESOP is the owner of all its stock...both allocated and unallocated shares. If the ESOP owns 50% of the company's common stock, it's entitled to 50% of the dividends. This is not a "windfall" to the ESOP participants. Would one suggest that the unallocated shares in the ESOP are not entitled to receive dividends? Would it be a "windfall" if the company decided to make an extraordinarily large ESOP contribution one year? Is it fair that the direct shareholders currently receive their dividends, but the ESOP participants may not? Is it fair that ESOP does not have tax liability on its dividends, but other direct shareholders do? Actually, one other approach may be to use dividends on unallocated shares to pay administrative expenses of the ESOP (to the extent agreed to by ESOP fiduciaries and permitted under the ESOP documents and ERISA).