RLL

Hi Alan Stonewall --- Assuming that the ESOP documents include appropriate provisions, the S corporation distribution attributable to the suspense account (unallocated shares) could be used for ESOP loan payments, could be used to acquire additional shares of available company stock, could be accumulated in cash or other investments, or could be "passed-thru" currently to ESOP participants and beneficiaries. In all events, the S corporation distribution will inure to the benefit of the ESOP participants and beneficiaries (except, perhaps, to the extent applied to loan interest payments that do not "release" shares for allocation to participants" accounts). Why is it "unreasonable" for a shareholder (the ESOP) to receive its pro-rata share of corporate dividends (the S corporation distributions)? An owner of rental real estate that is subject to debt is still entitled to receive the entire net rental proceeds as long as he/she makes debt payments as and when due. An owner of income-producing property (including an ESOP) is entitled to receive the income generated by that property. Where's the "windfall" ? If this is of such great concern, why didn't someone think about it while the ESOP transaction was being structured?

gaham --- Read the Senate Finance Committee explanation of IRC section 409(h)(4). The purpose of the two put option periods was to give the distributee the right to wait until a new (possibly higher) valuation is available in the following plan year. The plan provision does not conform to IRC section 409(h)(4). I assume that you've received (or will receive) an IRS determination letter on the termination of the ESOP. Maybe the ESOP fiduciary must insist upon an amendment as a condition of making the termination distributions, as there should be an opportunity for the distributees to wait and sell stock at the 12/31/02 valuation.

Hi gaham --- I think that the real problem here may result from the late November distribution date. Assuming that the 12/31/01 fair market value would be used for the first put option, the valuation is "stale" in November. If there has been a rising value (since 12/31/01), the repurchase would not be "under a fair valuation formula," as required by IRC section 409(h)(1)(B). The dual put option periods requirement of section 409(h)(4), which must take into account the "fair valuation" requirement of section 409(h)(1)(B), did not contemplate a distribution so late in the plan year without there being an updated valuation. In addition, note that the second put option period would not begin until the fair market value as of 12/31/02 has been determined and communicated to those distributees who did not exercise put options during the first put option period. This probably would eliminate your concern over having "overlapping" put option periods.

Hi SCUDDESLER --- The ESOP plan document must be duly adopted by the company (usually requiring formal action by the board of directors) not later than the last day of the company's taxable year. In addition, a valid ESOP trust agreement (which may be included as part of the ESOP plan document or may be a separate document) must be duly adopted by the company and executed by both the company and the initial ESOP trustee(s) not later than the last day of the taxable year. Just as with the adoption of any other type of qualified employee plan under IRC section 401(a), there is no requirement that the ESOP trust be funded by year-end so long as contributions for that taxable year are paid to the trust by the due date (including any extension) for filing the company's federal income tax return, per IRC section 404(a)(6). The ESOP's initial acquisition of stock may be made at any time, either before or after the close of the taxable year and either before or after the due date for making contributions. Note, however, that in order for ESOP contributions (which are used by the ESOP for loan payments) to be deductible under the special provisions of IRC section 404(a)(9), the ESOP loan should be in effect by the close of the taxable year....and any interest accruing on the loan after the close of the taxable year would likely not be deductible for that year.

Hi vebaguru --- If there are no firms there that specialize in ESOPs, retain an out-of-town expert. You can find referrals through The ESOP Association at www.esopassociation.org and the National Center for Employee Ownership at www.nceo.org.

Hi stephen --- An S corporation which is 100% owned by an ESOP may obtain automatic approval to use a tax year (other than the calendar year) that is the same as the ESOP's tax year. In situations where the ESOP owns a majority of the stock, but less than 100%, the S corporation may request IRS approval to use the ESOP's tax year as its tax year.

Hi tonys --- Why don't you just pay off your debts to the federal government and then allow your ESOP and 401(k) benefits to be available for funding your future retirement income?

Hi pensionadmin --- It's better to show the allocation in shares, as the dollar amounts used for loan payments are likely to be very different from the post-transaction value of the allocable shares. Since the benefits that participants will derive from the ESOP are based on share values, it makes more sense to reflect allocations in shares to the extent possible. This may be difficult if you can't determine the number of shares that will be allocable until September but want to provide participant statements at an earlier date.

JONB --- If the company continues to repurchase stock without disclosure of material facts, it would likely be violating antifraud provisions of federal and state securities laws.

Hi JONB --- The company should NOT continue to repurchase the stock at the old ("stale") valuation....unless it is willing to disclose the possible effect of its discussions with the potential buyer.

Pat S. --- There are many ERISA lawyers who do not have expertise in dealing with ESOPs. Your client should use a lawyer with extensive experience with ESOP loans.

Dawn and Pat S. --- Under Reg. section 54.4975-7(B)(13), an ESOP loan must be for a specific term. If a line of credit were used as an ESOP loan, each draw down of funds should be converted into a term loan. Under Reg. section 54.4975-7(B)(4), the proceeds of an ESOP loan must be used to purchase employer stock or to repay a prior ESOP loan. The loan proceeds may not be used to make distributions of ESOP benefits in cash. These are only some of the concerns raised by the proposed arrangement under the ESOP loan regulations. It is very difficult to address all of the pertinent issues in a message board forum such as this. Perhaps your client should be consulting with legal counsel who has more experience working with ESOP loans and benefit distributions.

Hi Dawn --- Is the line of credit is guaranteed by a party in interest or does it otherwise constitute an extension of credit to the ESOP from a party in interest? If not, it is not subject to the requirements of the ESOP loan regulations. If so, there are some problems with what you've described that I can address if you answer this question. Under IRC section 409(h)(2), any ESOP may provide for a distributee to elect between cash or employer stock as the form of distribution.

Hi Dawn --- Any ESOP under IRC section 4975(e)(7), including an S corporation ESOP, must be a stock bonus plan (or a combination stock bonus-money purchase plan) qualified under section 401(a). The regulation that you cited was adopted long before sections 401(a)(23) and 409(h)(2) were added to the IRC and is obsolete to the extent that it conflicts with such provisions.

Hi Belgarath --- I think that the right of participants to direct investments is a plan feature that may be terminated....but this seems like a bad idea. Technically, there is probably nothing that would prohibit transferring the profit sharing accounts to the ESOP (subject to compliance with various IRC requirements). Whether or not such assets are then invested in company stock would then be a fiduciary decision....best considered by an experienced and truly independent fiduciary. What about allowing participants to direct investments into company stock (with independent fiduciary monitoring and disclosure appropriate to comply with applicable securities laws)?

Hi J2D2 --- The restriction is permissive. Nothing in section 409(o) prevents the distribution of shares prior to the repayment of the ESOP loan. If the provisions of the ESOP plan document allow such a distribution and the participant consents (if required), the shares may be distributed. In fact, in certain situations section 401(a)(9) and (14) may require that distributions commence prior to the repayment of the loan.

Hi Karen Givens --- As a general rule, a money purchase pension plan may invest up to 10% of its assets in company stock under ERISA section 407(a), subject to compliance with the fiduciary rules of ERISA section 404(a). However, a money purchase pension plan may be part of an ESOP, per IRC section 4975(e)(7) and ERISA section 407(d)(6); and such a money purchase plan could use up to 100% of its assets to purchase company stock, per ERISA section 407(B), subject to the fiduciary rules of ERISA section 404(a) and compliance with various "ESOP requirements" of ERISA and the IRC.

Hi Aidin --- Under ERISA it may constitute a prohibited transaction for the ESOP's stock to be sold for a note in such a transaction...as such a transaction could result in there being a prohibited extension of credit from the ESOP to the sponsoring employer...unless the ESOP is being terminated prior to the completion of the transaction. I agree with you that this proposed sale doesn't "smell right." If the ESOP owns 1/2 of the total outstanding shares of the company, it is in a position to block the sale on such terms and/or to negotiate for a better deal. Who is looking out for the interests of the ESOP participants?

efrueh --- Are you a "competent legal counsel and /or other adviser familiar with the nuances of ESOPs" ?

Hi tldresch --- What does the ESOP plan document provide? Unless there is a provision which "offsets" one benefit distribution right against the other, the participant is entitled to both. The plan document controls (I assume that there is a determination letter from the IRS).

Hi efrueh --- A truly independent fiduciary (experienced in ESOP financing transactions) should be retained to negotiate the terms of the refinancing on behalf of the ESOP.

Hi eilano --- If the unrelated 3rd party is not a "party in interest" under ERISA, such a loan may be made by the ESOP....but only if the ESOP remains invested "primarily" in employer stock and the applicable ERISA fiduciary rules (prudence, "solely in the interest" of participants, diversification of non-employer stock investments, etc.). are satisfied.

Hi Sharon G. --- Reg. section 54.4975-7(B)(5), relating to ESOP loans, limits the ESOP assets that may be used for loan payments....and only contributions "that are made under an ESOP to meet its obligations under the loan" may be so used. Unless those prior years' "excess" contributions were made to enable the ESOP to make loan payments, the amounts now attributable to participants' cash accounts may not be so used.

Hi CitationSquirrel --- Check out past issues of the Journal of Employee Ownership Law & Finance , which is published by the National Center for Employee Ownership (www.nceo.org). Also, in the early 1990s (?), the DOL published an interpretative bulletin on the responsibilities of fiduciaries in connection with corporate governance issues involving portfolio investments of employee benefit plans.

Hi tldresch --- The participant is entitled to receive both the "regular" installment distribution and the diversification distribution.