BeckyMiller

See Letter Ruling 200008040, November 29, 1999 for a discussion about partnerships, ESOPs and controlled groups. It doesn't create a clear conclusion on this issue, but does lay out the framework to be considered in making the decision.

Nasty, nasty situation. There is a ton of case law on this subject that arose in response to the October 1987 stock market crash. During this timeframe, we say fewer daily valued plans, so the facts would be more like your situation. See for example, Holian v. Leavitt Tube Co., (N.D. Ill., Civ. No. C. 89-0354 (1989), Bachelder v. Communications Satellite Corp., (837 F.2d 519 (1st Cir. 1988)), Pratt v. Maurice L. Brown Employee Savings Plan, (9 E.B.C. 2380 (D.C. Kan., June 30, 1988)) and Pratt v. Petroleum Production Management, Inc. Employee Savings Plan and Trust, (CA-10, Dkt. No. 88-2190) . You should run these cases through a citator to see what has happened since then. I have not updated this research for a long time. However, the conclusions are not very helpful. They tend to say that the plan can't be amended to change the distribution date (or even to exercise an existing separate valuation date) if that hasn't been done in the past. NOW since this is a former owner, you might have a better case. Since the amounts are so large, I strongly advise getting competent ERISA counsel. (I am not an attorney, just an ERISA historian.)

First Welcome!!! Second, as a participant in a 403(B) plan of a government unit the rules are a little foggier than for folks in a 401(k) plan. Your plan is not subject to ERISA - the Employee Retirement Income Security Act of 1974. That act includes specific rules and enforcement actions regarding employers who fail to deposit employee retirement contributions within a reasonable time frame. A 403(B) plan of a governmental unit is not subject to that law. Now, you didn't say that this was a public university, but.... that may not help. Even if it is a private university, ERISA Regulation 2510.3-2(f) says that 403(B) plans are not subject to the act if the sole involvement of the employer is to facilitate the employee's savings through payroll withholding. So..even if you are with a private university, you may not be covered by ERISA. However, if it is a private university and the employer makes contributions to this program, it is subject to ERISA. In that case the rule is that it has to be deposited not later than the 15th business day of the month following withholding. ERISA Regulation 2510.3-102(B). This is a critical issue for the DOL and they are actively enforcing this matter. You can contact an enforcement officer at your regional office. See http://www.dol.gov/pwba/AboutPWBA/org_char....html#section13 However, before contacting the DOL, I would ask your personnel office what was going on. It may be that they are in the midst of changing service providers and the funds have been deposited for your benefit, but not yet transferred to the investment house... If you are not an ERISA plan, you have to work with the IRS. That is a more cumbersome process. If this is a serious problem, that is, when you ask, you get no good answers, you might try contacting one of the pension advocacy groups. They can give you better insight than I. For example, try the Pension Rights Center.

Sorry - I gave you the wrong reg. I always get the short period and the 80 to 120 citations confused. The correct cite is 2520.104-50. This reg. provides: .--(a) Definition of "short plan year." For purposes of this section, a short plan year is a plan year, as defined in section 3(39) of the Act, of seven or fewer months' duration, which occurs in the event that--(1) a plan is established or commences operations; (2) a plan is merged or consolidated with another plan or plans; (3) a plan is terminated; or (4) the annual date on which the plan year begins is changed. (B) Deferral of accountant's report. A plan administrator is not required to include the report of an independent qualified public accountant in the annual report for the first of two consecutive plan years, one of which is a short plan year, provided that the following conditions are satisfied: (1) The annual report for the first of the two consecutive plan years shall include: (i) Financial statements and accompanying schedules prepared in conformity with the requirements of section 103(B) of the Act and regulations promulgated thereunder; (ii) An explanation why one of the two plan years is of seven or fewer months' duration; and (iii) A statement that the annual report for the immediately following plan year will include a report of an independent qualified public accountant with respect to the financial statements and accompanying schedules for both of the two plan years. (2) The annual report for the second of the two consecutive plan years shall include: (i) Financial statements and accompanying schedules prepared in conformity with section 103(B) of the Act and regulations promulgated thereunder with respect to both plan years; (ii) A report of an independent qualified public accountant with respect to the financial statements and accompanying schedules for both plan years; and (iii) A statement identifying any material differences between the unaudited financial information relating to, and contained in the annual report for, the first of the two consecutive plan years and the audited financial information relating to that plan year contained in the annual report for the immediately following plan year. © Accountant's examination and report. The examination by the accountant which serves as the basis for the portion of his report relating to the first of the two consecutive plan years may be conducted at the same time as the examination which serves as the basis for the portion of his report relating to the immediately following plan year. The report of the accountant shall be prepared in conformity with section 103(a)(3)(A) of the Act and regulations thereunder. In other words - you don't need the audit to be filed for the 12 months that ended October 31, 2001. You have to file a report with the 5500 for the period ended December 31, 2001. That report includes a statement of net assets as of 10/31/2000, 10/31/2001 and 12/31/2001. It includes a statement of changes for 11/1/2000 to 10/31/2001 and 11/1/2001 through 12/31/2001. On the 5500 for the year ended 10/31/2001 you just note that the audit report is being deferrred pursuant to this reg. Sorry for the wrong cite.

See ERISA reg. (see second message below). This is the short plan year rule. You can't do a 14 month report, but you can waive the audit for the short year, as long as that period is included in the audit report for the prior 12 months or the subsequent 12 months. In this case, I would do it as part of the 10/31/2001 report. So, you would end up with 10/31/2000, 10/31/2001 and 12/31/2001 statements of net assets.

This letter ruling needs to be read very narrowly. The facts in the ruling were that the valuation date was monthly, but several months would pass from the valuation date until distribution without any allocation of earnings. So, they were violating the written terms of the document. If you have quarterly valuation dates and make distributions within 30 or 40 days, you are not violating the document terms. The enforcement agency was the DOL. The IRS's involvement in the ruling request related to the tax consequences of the restorative payment.

lforesz - remember, the Form 5500 series of reports now originates with the DOL, so that is the place to go for guidance on most of this stuff. In this case, you should look to a letter from the PWBA Office of Regulations and Interpretations on December 12, 2001 to Mr. Stephen M. Saxon of the Groom Law Group relating to the Schwab PCRA that letter states: "The accounts, commonly referred to as "brokerage windows," allow participants the opportunity to purchase stocks, bonds, mutual funds or other investments that are not offered as part of the plan's main investment alternatives. The brokerage account provider typically performs recordkeeping for assets in the accounts." So - I think that is a good working definition of this concept.

Ms. Gaskins - I suggest that you check the webpages of the two ESOP leadership organizations to get insight on this matter. They are The ESOP Association at www.esopassociation.org and The National Center for Employee Ownership at nceo.org. Both had a lot of information on ESOPs and S corporations. As a practical matter, it is very common in ESOP companies that the trustee is a committee of internal management. These persons, however, must remember their duty to the plan, not to themselves when voting these shares. Second, if this is a small company, you need to look at the new broadly-held rules of IRC Section 409(p) for a new plan these are immediately effective. The impact of this provision is critical to any analysis of the feasibility of an ESOP. Note, these rules don't prohibit the use of an ESOP, they may reduce the amount of benefit that these 3 persons can accrue under that ESOP or they may make C corporation status more attractive.

If it is decided after the efforts described above that this is a funded plan for which Forms 5500 were due, look at the revised delinquent filer program. Though it will be costly to prepare the required Forms 5500, the fines have been substantially reduced. See http://www2.dol.gov/dol/pwba/public/pubs/0...fact_sheet.html The total penalty for a small plan is only $1,500 regardless of the number of years filed. The IRS has agreed to cooperatewith the 5500 relief program, but that doesn't cover the 990. If you have to file Forms 5500, realize that there is no statute of limitations under ERISA for these forms. But, the penalty for failure to file only applies to forms required to be filed after December 31, 1987.

Good point QDROphile, I missed that comment. I was just focusing on the valuation requirement. Dawn - the ESOP loan exemption only goes one way. A related party can lend to the ESOP, but the ESOP can't extend credit to a related party. So, if you want to discuss this aspect you better expand upon what you intended.

This continues to be uncertain territory. The AICPA is attempting to grapple with the issues. The DOL wants to protect the P's and B's. I have anecdotal evidence on one situation of a Big 5 firm doing both where the DOL was more frustrated by the absence of real audit procedures than the fact that the CPA firm did both. If you look at the Interpretive Bulletin, it says that the CPA firm may not "maintain the records" of the plan. So, many CPA firms argue that they are not "maintaining" records, but merely providing clerical or technical assistance. For this reason, we strongly suggest that any CPA firms participant accounting department make sure that the client is responsible for maintaining copies of all relevant documents, actively participates in all decisions and interpretations of the plan, etc. Note, that the Interpretive Bulletin does say that a CPA firm is independent when its actuaries perform the actuarial calculations for the defined benefit plan under audit. To me, this is more risky than doing participant accounting services on a defined contribution plan. In other words, the government's guidance is not entirely clear. Personally, I would hate to see CPA firms going out of this business. With their focus on technical issues and detail, they tend to do a really good job on the participant accounting. I think, however, that if you are going to be aggressive in this area you need to do 2 things. 1. Really audit the plan, applying all skepticism to the work of your own people, even greater than what you might apply to an outside firm. 2. Realize that if the DOL finally announces a firm position on this matter, your firm is probably going to be the entity at risk for any penalties for an incomplete Form 5500 filing due to an unacceptable audit.

I would say that the shareholders can receive an allocation in the profit sharing plan, as long as that contribution is made in accordance with that plan's terms and otherwise satisfies the non-discrimination rules. If you look at the non-discrimination rules regarding the treatment of persons excluded from receiving benefits because of a 415 limit or 409(n), you can readily get confused. When applied to Section 409(n), I tend to use the language in the 401(a)(4) regulations very cautiously. (For example, if everyone hits their 415 in the ESOP, so your 2 owners are the only folks who get a profit sharing contribution, I would get nervous. Others might not.) Besides, this won't work for 2002 years or later, where we no long have the 25% of pay individual allocation limit.

You know this, but I have to start here anyway. 1. Follow plan document where relevant. 2. If all other participants get their distributions based upon the immediate prior valuation date, I would use the same approach in this situation. 3. However, if the company has to redeem some of the shares to fund this distribution, you have a different situation. Here you have a related party sale that must satisfy the prohibited transaction rules. IRC Reg. Section 54.4975-11(d)(5) requires that the valuation be set as of the date of the transaction. Thus, you would need some determination of value as of the date that the ESOP sells the stock to the corporation.

You need to get some professional advice. One approach to this issue can result in virtually no income tax consequences. Another approach arrangement can make it look like your seller contributed capital to the company which then made the payment to him. A simpler approach might be to just defer the payment and tack it onto the end. But, watch out, this might change your collateral release method on the loan. Another approach is to refinance the current year's payment. All of these require the ESOP fiduciary to think about what is going on. Can fall into that trap of no good deed goes unpunished. Get a good ESOP attorney.

O.k. Tax accountant entering the fray. 1. The general discussion is pretty accurate to date. This is a corporation, the deduction is calculated just like a regular corporation. 2. The shareholder has to have W-2 wages to be a basis for the contribution. It is not calculated based upon his or her pass-through income. So, the fact that this puts the corporation into a loss position does not eliminate the right to make the contribution. 3. Even if it is a profit sharing plan that requires that the contribution be paid out of current profits, you may be o.k. There were sufficient current profits before the contribution. (Now, if you went into a loss situation, there might be a partial problem here.) Since 1986 few profit sharing plans have retained this requirement, however, so that particular limitation would surprise me. 4. It is very common for S corporation shareholders to make personal loans to corporations. The ability to deduct the S corporation losses on their personal returns is limited by a variety of rules. One is the "passive loss" rules. Another is that they cannot take a deduction in excess of their basis in the stock. Certain types of loans create basis.

Nope, this was part of the change in the law when they allowed S corporations to have 401(a) plan shareholders. If you think about it, it makes sense. The S corporations carries on a business. That business is subject to a single layer of tax at the shareholder level. Thus, this isn't passive income. This is active income. (They aren't taxed on the S distributions/dividends. They are taxed on their proportionate share of the corporate earnings.) If your comment is with regards to the gain on sale of the stock, I agree that taxation of that gain is totally inconsistent with the general rules. That would be passive income and it is really weird that it is taxed. But, it is specifically included as taxable by the language of the law. In fact, the Blue Book commentary also states that if the plan distributes this stock to a participant as a normal distribution, the gain is also taxable at that point in time. I think that is going over the top, and I would tend to disagree. It is not is the actual legislative history, just the Blue Book. But, we know that the IRS gives the Blue Book tremendous deference.

Getting back to the original question - realize that most S corporations pay dividends to allow its shareholders to pay tax on their share of the income. An ESOP is exempt from this tax (See IRC Section 512(e)(3). But, other 401(a) plans are subject to tax. You need to ask for the plan's copy of Schedule K-1, Form 1120-S. If the pass-through income is $1,000 or more, the plan must file Form 990-T and pay tax. If the income is high enough, the plan must also make estimated tax payments. The NASTY, NASTY thing about this provision is that the unrelated business income tax rules apply to both the pass-through income AND any gain on the sale of the stock. The instructions to Form 990-T are very helpful to guide you through this process.

Yes.... This is a common circumstance in any purchase of all of the equity of an enterprise. It can work, if properly done. I suggest that the ESOP fiduciary engage competent counsel and an experienced ESOP transaction trustee. Sorry for this kind of an answer, but you are getting into the area where we ESOP folks think we should get paid.

I am not sure that there is a "proper" method for correction. I would look to the fundamental principal behind the whole correction concept - put the affected participant into the same position that he or she would have been had the diversification election been offered. 1. That means that the participant had a choice. Since it is 20/20 hindsight at this point, I think you have to assume that the participant would have made whatever choice would have been correct based upon the known facts following the original election date. 2. If that meant that the participant would have diversified, treat them as having diversified at that price. Provide them with lost earnings. To the extent that the shares earned income while in the plan for this period, I think you can reduce the adjustment for lost earnings by these actual earnings. But, that is personal opinion. 3. If that means that means that they wouldn't have diversified (stock price rapidly rising at a faster rate than other investment options.) I think you have to deal with the potentially tougher question. What additional opportunities, if any, do you have to give them to diversify. Can you just ask them what they want to do at the point the error is discovered? Does the failure to meet the statutory standard subject the plan to the broader issues of securities law effects, penalties on distribution, etc.? 4. In either case, do you have to give them future diversification elections to make up the ones they missed? I think it would be clear that if you missed the first 2 elections, the participant gets the remaining 4. But, what if, as you outlined, they missed all 6 election periods? I have heard competent ESOP advisors suggest that the correction would require just one election at 50% and others suggest that the participant should be granted more periods. Obviously, this is an unsettled area. Periodically, Peat Marwick will publish a summary of recent settlements under the voluntary correction program. You might see if you can find one of those listings and see if this question has been submitted to the IRS by some other poor unfortunate.

In most ESOPs, the participant has little direct input into such decisions. Generally, the decision regarding what price to accept for the shares is made by the trustee. If your company has been bought out, there may not even be any shares left in your ESOP at this time. The trustees may have negotiated a selling price for the block of stock. In that case, you will have a right to a distribution based upon what is in your account balance following the sale. In some situations, the ESOP continues to hold stock after the acquisition. In those cases, the share price is set either by the market or some other independent determination, as required by the law. Is there something specific going on that has made you believe that you have some input in the pricing?

Can't give you a specific cite here, but we have always used the logic that these amounts are associated with the plan. As such, even if paid directly by the sponsor to the participant, the amounts should be shown on the Form 5500 series consistently as dividend income of the trust and distributions to the participants. This would also be consistent with the GAAP reporting rules.

point 4. Unfortunately, I have had the unhappy experience of trying to help out the employees and administrators of several private company ESOPs, where the share value has, in fact, gone to zero. The good news is that is quite rare, the bad news is that it has happened.

In the interests of full disclosure - Danny Miller and I may think alike, but we are not related.

An ESOP is still an ERISA plan. It has some PT exemptions and the diversification exemption. But it is not otherwise exempt from fiduciary conduct, exclusive benefit, etc. Almost all ESOPs are confronted with a concentration of risk in the plan sponsor - it is investment risk and cash flow risk. As such, the potential consequences of any fiduciary decisions seem more dramatic. I guess that is the primary difference. It sometimes feels like an all or nothing decision, rather than just fine tuning. Not sure about the fishing in Crow Wing. Rochester is over 100 miles south and east of Brainerd. But, isn't Minnesota fishing always good? Just sometimes better than others.

fidu - goes to the definition of "known loser." I was thinking in the context of no hope of recovery, not just currently undervalued.