RLL

Hi Christine --- Where have you been since last October? I think that your questions were answered adequately in the earlier thread.

Hi GS1100 --- What do the loan documents say? The ESOP is required to make loan payments only to the extent provided in the loan documents. In determining the number of shares to be released for allocation each year under the P + I rule, if the interest rate under the loan is variable, the interest to be paid in future years must be computed by using the interest rate applicable as of the end of the plan year.

Hi ubpMR --- Check the web sites of the National Center for Employee Ownership (www.nceo.org) and the Beyster Institute for Entrepreneurial Employee Ownership (www.beysterinstitute.org). For additional information on just ESOPs, see the web site of The ESOP Association (www.esopassociation.org).

Hi Cribbet --- The proceeds of an "exempt" ESOP loan under IRC section 4975(d)(3) and ERISA section 408(B)(3) can only be used by the ESOP to acquire employer stock or to refinance an existing ESOP loan. Such an "exempt" ESOP loan cannot be used to provide funds for ESOP diversification. However, if the proposed loan did not involve a party in interest (it is not from or guaranteed by a party in interest, such as the employer), it would likely not fall within the purview of the prohibited transaction rules....although it would still be subject to the fiduciary rules of ERISA section 404(a)(1). An easier solution might be to amend the ESOP to provide for effecting diversification through benefit distributions (rather than through investments under the ESOP). Shares of employer stock could then be distributed to participants who elect diversification. If the trustee or employer did not want employer stock distributed, it is possible (under a DOL prohibited transaction class exemption) for the employer to make interest-free loans to the ESOP for funding cash benefit distributions.

Hi David Stovall --- If the employer contributes $516,000 which the ESOP uses in a timely manner to pay the principal and interest due on the ESOP loan, the $516,000 will be deductible under IRC section 404(a)(9)....if the covered payroll is at least $504,000, if the employer is not an S corporation, and if there is no violation of section 415. In addition, the $365,000 in interest paid by the employer to the bank will be deductible as a payment of interest....[but not under section 404(a)(9)]....and the $390,000 of interest paid by the ESOP will be taxable to the employer as interest income.

Hi GS1100 --- It can be done in the same manner as reallocation of shares following benefit distributions in cash.

Hi tfurlong --- IRC section 404(a)(9) allows contributions that are used for ESOP loan principal payments to be deductible in amounts up to 25% of covered payroll; and also allows for contributions that are used for ESOP loan interest payments to be deductible without a specific limit. In the case of a typical "back-to-back" ESOP loan arrangement, the loan to which section 404(a)(9) refers is the sponsoring company's (internal) loan to the ESOP....there is no deduction thereunder that relates to the company's "external" bank loan (except to the extent that the two loans might be "matched"). The company's contributions that are used by the ESOP to pay loan interest (to the company) are deductible, but such deductions are "offset" by the interest income received by the company. Note that section 404(a)(9) is not available to S corporations.

CRC02 --- Read the committee reports under the Tax Reform Act of 1986, which added subsection (o) to IRC section 409. I'm not aware of any IRS guidance on this issue....but you might want to check the ESOP Examination Guidelines.

Hi CRC02 --- Your colleague is correct. IRC section 409(o)(1)© merely limits an installment distribution to a five-year period.....it does not require an "annuity" and does not prevent an ESOP from providing that a lump sum is the only available distribution option.

Hi amboyd --- The put option requirements of IRC section 409(h)(1)(B) would apply to distributions of stock (that is not "readily tradable") in connection with the termination of the ESOP, including the requirement for two put option periods under section 409(h)(4).

Hi eilano --- If key person life insurance is purchased, the buyer should be the company and not the ESOP. There are too many issues/problems to deal with if the ESOP buys the life insurance. What happens to the company if the key employee retires or otherwise leaves the company for a reason other than death? This is also a risk that you might think about. Perhaps something should be done to put other employee owners in a position where they can replace the talent of this key employee (when it becomes necessary to do so).

Hi DBolling --- If the interest payments were made from S corporation distributions on the suspense account shares, the shares released thereby should be allocated in the manner provided (in the ESOP plan document) for the allocation of dividends on unallocated shares. Sometimes this is done in proportion to account balances (as trust income); sometimes it's done in proportion to current compensation (the same as employer contributions). Check the plan document! Also, in a money purchase plan, the contribution formula amount sets the required employer contribution, without regard to the current value of any released shares. Look at the amount the employer contributes, not the value of the released shares that get allocated to participants' accounts. Appreciation in value of the leveraged shares should inure to the benefit of participants and should not be used to reduce the employer's contribution obligation. The section 415© annual additions are based on the lesser of (a) the amount that the employer contributes, and (B) the value of the released shares allocated to participants' accounts (so long as the ESOP plan document so provides). If the released shares have appreciated in value, such increase is not included under 415©.

mbozek --- If the fair market value per share is $11 on the contribution date, the employer's deduction is $11/share. It doesn't matter how much (if anything) the employer paid to purchase the shares of employer stock. Ephrail --- If you treat a stock contribution as a contribution of cash with a simultaneous purchase of stock (at then fair market value), it makes sense to use the value on the actual contribution date as the amount contributed for purposes of IRC section 412.

Hi mbozek --- The dividend deduction provisions of IRC section 404(k) are available to a C corporation that maintains any statutory ESOP under IRC section 409(a) or IRC 4975(e)(7). Such ESOP may be a "stand-alone" ESOP....OR it may be combined or coordinated with (or be a portion of) some other qualified plan under IRC section 401(a), including a 401(k) plan. The dividend deduction under section 404(k) is available for reinvested dividends only if the ESOP participants may elect to receive such dividends in cash.

Hi MWeddell --- The "ESOP exception" to the expanded diversification rights in the House-passed bill also applies to all ESOPs of closely-held companies (whether "stand-alone" or not).

Hi JTM --- The ESOP diversification election under IRC section 401(a)(28)(B) is limited to that portion of a participant's account that is represented by shares of employer stock allocated under the ESOP portion. In counting "years of participation" for this purpose, it is possible that the IRS would consider the 401(k) plan to be a "predecessor plan" and require "tacking" of years under the ESOP....but this is an unclear area. In designing the ESOP, however, the employer may desire to specifically exclude the pre-ESOP years when drafting the plan document. If the ESOP then receives a determination letter from the IRS with such an exclusion, the pre-ESOP years can be disregarded.

mbozek --- No......

Hi mbozek --- We're discussing contributions of employer stock here. A corporation does not recognize gain or loss in connection with sales or purchases of its own stock.

Eprail --- Both the IRS and the DOL treat a contribution of property (such as employer stock) which is made to satisfy a contribution obligation as the equivalent of a contribution of cash with an immediate purchase of stock at the then fair market value. Maybe you can find something more on this by researching the prohibited transaction issues relating to contributions of property.

Hi texastax --- It is clear that the nonvoting stock would not be "employer securities" under IRC section 409(l). However, an ESOP under IRC section 4975(e)(7) is merely required to be "designed to invest primarily in employer securities." Accordingly, so long as the ESOP meets that requirement (probably through being more than 50% invested in the employer's voting common stock), it could also hold shares of the nonvoting common stock. Note, however, that the IRC section 512(e)(3) S corporation ESOP exception to taxation of unrelated business income would be limited to the ESOP's interest in the voting stock....that is, the S corporation taxable income attributable to the ESOP's nonvoting stock would be subject to tax.

Hi Eprail --- It is clear that the market value as of the contribution date is used for purposes of IRC sections 404(a) and 415©.....see Reg section 1.415-6(B)(4) for the rule under section 415. For these purposes, the IRS position is that differences in value between the contribution date and the allocation date are treated as appreciation or depreciation in the stock value that does not effect changes in the $ amount of the employer's contribution (but only changes the $ amount allocated to participants' accounts as of any other date). It thus appears that IRS would apply the same rule under section 412....unless there's something in the 412 regs that says otherwise (you can do the research).

pjkoehler --- The discussion in this thread was changed (by BeckyMiller and you) from the issued raised in the original message. I never responded to the first message....I just followed up on the discussion as it subsequently developed. According to the original posting, there was no default on the ESOP loan and nothing to renegotiate.....the lender unilaterally waived his right to a payment due from the ESOP.

pjkoehler --- Have you not ever heard of a borrower & lender renegotiating the terms of a promissory note? An ESOP fiduciary may certainly renegotiate the terms of an ESOP loan, including extending the term of the loan, without violating the ESOP loan regulations, so long as such loan modification is "primarily for the benefit" of the ESOP participants. A modification of an ESOP loan to prevent a default (and possible resulting loss of shares by the ESOP) and to alleviate the employer's financial difficulties (thereby possibly protecting the value of the ESOP's investment in employer stock) may very well be in the best interests of the ESOP participants. ESOP fiduciaries must exercise their responsibilities by investigating all such options that may be available. The ERISA "document rule" certainly does not prevent a fiduciary from agreeing to modify applicable documents in appropriate circumstances in order to protect the interests of the ESOP and its participants.

pjkoehler --- Why would you transfer shares back to the lender if the lender doesn't want the shares back? The normal arrangement for pledging shares as collateral for the ESOP loan does not require that shares be transferred to the lender in the event of default....it merely provides that as a remedy available if the lender so elects. I like BeckyMiller's approach of merely extending the term of the loan. If this is done properly, there should be no adverse consequences to any party.

Hadden2001 --- There is no question about it....the employer's note is a prohibited extension of credit from the plan to the employer under ERISA section 406(a) and IRC section 4975. The exemption under ERISA section 408(e) covers the sale/purchase of the stock, but not the extension of credit.