BeckyMiller

As a partner, the payment should be reported on Schedule K-1, not a 1099 or W-2. It is likely to be characterized as net earnings from self-employment, so it would typically be considered compensation under the plan. BUT, the individual may not be an eligible participant for 2007 as he or she may not have any hours of service. So, you need to look at the plan document to determine whether the income is eligible for any benefit under the plan.

Look at ERISA reg. 2520.104-20. Since you note that the employee contributions are pre-tax, I have assumed that they are under a cafeteria plan so the general non-enforcement position for cafeteria plans would apply. See PWBA Notice, August 27, 1993, modifying ERISA Technical Release 92-01, 6-2-92, superseding Technical Release 88-1, 8-12-88. So, if you meet all of those, your client would not have to file Form 5500 until their participant count hit 100.

IRC Section 401(a)(28) sets a minimum standard. Many plans choose to offer diversification rights that are more generous than what the Code requires. Such a privilege needs to satisfy the nondiscrimination standards for "other benefit rights and features" at 1.401(a)(4)-4(b)(2)(ii)(A). It is generally pretty easy to satisfy these standards because of this special language on testing availability by disregarding age and service conditions. Now - in this world of risk management - this diversification practice has always raised issues of securities law. In general, the SEC has allowed that compliance with the required diversification will not trigger the application of securities law, but they were silent with respect to extended diversification privileges. In my experience, they have remained silent. I have not seen anyone suggest that if you grant diversification privileges in excess of the required standard that you MUST comply with securities laws. But, I have not seen anyone specifically say that you don't have to comply, either. So, prudence dictates that you check with counsel. I am hoping Kurt is reading these posts, as he spends a fair amount of time on these issues and I am just dealing with rumor and hearsay.

You might suggest that your client or their legal counsel contact the ESOP Association, ESCA or the NCEO for names of attorneys who are focusing on this issue. I have heard a lot of conversation at cocktail parties where certain advisors think that these regulations are so severe that they need to be challenged in Court to see if they go beyond the intent of Congress. Now - I can't say that your client may have much hope - Congress did give the Secretary a fair amount of authority in this regard and there were cocktail parties, so it may have just been the liquor talking.... But, if big amounts are involved, your client may wish to pursue this further.

That is correct, see http://www.dol.gov/ebsa/regs/fedreg/final/20071116.pdf for the final guidance from the DOL.

Have they already failed 409(p) or are you just projecting that they will fail? This test has that nasty requirement to be satisfied on each day of the plan year. Under the final regulations, it is very difficult to correct an existing failure unless the plan already includes some correction language. I know it seems like we say this way too frequently in this board, but you should contact legal counsel who are experienced with ESOPs of S corporations.

I think the IRS publication has made too general a statement. In the definition of a lump-sum in IRC Section 402(e)(4) specific reference to the aggregation of plans is made, as follows: 402(e)(4)(D)(ii) AGGREGATION OF CERTAIN TRUSTS AND PLANS. --For purposes of determining the balance to the credit of an employee under clause (i) -- 402(e)(4)(D)(ii)(I) all trusts which are part of a plan shall be treated as a single trust, all pension plans maintained by the employer shall be treated as a single plan, all profit-sharing plans maintained by the employer shall be treated as a single plan, and all stock bonus plans maintained by the employer shall be treated as a single plan, and 402(e)(4)(D)(ii)(II) trusts which are not qualified trusts under section 401(a) and annuity contracts which do not satisfy the requirements of section 404(a)(2) shall not be taken into account. So - if the 401(k) plan is a stock bonus type plan, then it would be combined with the ESOP. But, if it is a profit sharing type 401(k) plan, you can take separate distributions. You need more information.

In a number of public forums, the DOL's Chief Accountant, Ian Dingwall, has stated the the penalty for the failure to attach an acceptable ERISA set of audited financial statements is $50,000. Our experience has been that if you cooperate and get an acceptable set of audited statements submitted, you can negotiate down from that penalty, even outside of the organized relief programs. But, you need to timely respond to requests for information, demonstrate a cooperative attitude and all of that stuff.

You need to check IRC reg. 1.1377-1(a)(2). If it is really immediate, they get no K-1 as stock ownership is measured at the beginning of the day. So, if they only hold it for a small portion of the day, they are not a stockholder for purposes of allocating activity.

They may be o.k. See Q&A-3 of 1.419-1T. Q-3: What is a "welfare benefit fund" under section 419? A-3: (a) A "welfare benefit fund" is any fund which is part of a plan, or method or arrangement, of an employer and through which the employer provides welfare benefits to employees or their beneficiaries. For purposes of this section, the term "welfare benefit" includes any benefit other than a benefit with respect to which the employer's deduction is governed by section 83(h), section 404 (determined without regard to section 404(b)(2)), section 404A, or section 463. (b) Under section 419(e)(3)(A) and (B), the term "fund" includes any organization described in section 501©(7), (9), (17) or (20), and any trust, corporation, or other organization not exempt from tax imposed by chapter 1, subtitle A, of the Internal Revenue Code. Thus, a taxable trust or taxable corporation that is maintained for the purpose or providing welfare benefits to an employer's employees is a "welfare benefit fund." © Section 419(e)(3)© also provides that the term "fund" includes, to the extent provided in regulations, any account held for an employer by any person. Pending the issuance of further guidance, only the following accounts, and arrangements that effectively constitute accounts, as described below, are "funds" within section 419(e)(3)©. A retired lives reserve or a premium stabilization reserve maintained by an insurance company is a "fund," or part of a "fund," if it is maintained for a particular employer and the employer has the right to have any amount in the reserve applied against its future years' benefit costs or insurance premiums. Also, if an employer makes a payment to an insurance company under an "administrative services only" arrangement with respect to which the life insurance company maintains a separate account to provide benefits, then the arrangement would be considered to be a "fund." Finally, an insurance or premium arrangement between an employer and an insurance company is a "fund" if, under the arrangement, the employer has a right to a refund, credit, or additional benefits (including upon termination of the arrangement) based on the benefit or claims experience, administrative cost experience, or investment experience attributable to such employer. However, an arrangement with an insurance company is not a "fund" under the previous sentence merely because the employer's premium for a renewal year reflects the employer's own experience for an earlier year if the arrangement is both cancellable by the insurance company and cancellable by the employer as of the end of any policy year and, upon cancellation by either of the parties, neither of the parties can receive a refund or additional amounts or benefits and neither of the parties can incur a residual liability beyond the end of the policy year (other than, in the case of the insurer, to provide benefits with respect to claims incurred before cancellation). The determination whether either of the parties can receive a refund or additional amounts or benefits or can incur a residual liability upon cancellation of an arrangement will be made by examining both the contractual rights and obligations of the parties under the arrangement and the actual practice of the insurance company (and other insurance companies) with resepct to other employers upon cancellation of similar arrangements. Similarly, a disability income policy does not constitute a "fund" under the preceding provisions merely because, under the policy, an employer pays an annual premium so that employees who became disabled in such year may receive benefit payments for the duration of the disability.

Natasa - I suggest that you go to www.nceo.org and select the ESOP pages. There is a lot of great education tools there on understanding ESOPs.

What CCH resource are you using? For some reason the rulings listing under pensions and payroll is limited, but if you go the the Federal tax tab, they are all there.

Nope - two different concepts that unfortunately use similar words. See IRC Section 409(p) or 409(n) for ESOPs and Section 4975 for prohibited transactions.

See http://benefitslink.com/IRS/5500.html Go to item 5. This is the DOL response to questions about the definition of an allocated contract. This is currently very controversial with many financial providers claiming that their investments are not subject to audit or reporting because they satisfy the definition of an allocated contract.

The excise taxes are not deductible as they are a penalty. But, the payment to the plan for lost earnings has been repeatedly ruled by the IRS to be a deductible expense - basically as a normal trade or business expense. There are many, many PLRs that conclude this. Just search for correction and 415 and you should pull them up. I realize we can't rely on a PLR that is not issued to our client, but this is such an overwhelming trend, that you should be able to rely on the same logic as the Service.

So - did legal counsel concur or did the client just decide they didn't want to deal with the risk that you might be right? I am curious about the statutory authority, if any, counsel provided for saying this was permissible. But, it is simply curiousity....I don't need to know.

Whoa there, buckaroo. You need to go to the final 415 regulations. 1.415-6(b)(7) To get the deduction on the 2006 return, the rules of IRC Section 404(a)(6) must be met - that includes a DEPOSIT not later than the due date of the return. The extra 30 days is ONLY for the 415 limits. Some folks believe that this does allow you to game the tax years - count something against the 415 limit for one year, but be deductible in the subsequent year. Other folks think that IRC Section 404(j) or is it (h) (don't have my Code on me) requires that for any amount to be deductible it has to be ALLOCATED in the year deducted. If you are in the liberal school - meaning it just has to be allocated by year end, not with respect to that year, then if you made the contribution within 30 days of the 404(a)(6) due date, it would count against 415 for 2006 and be deductible in 2007.

Because an ESOP of a private company is invested in non-traded, meaning not liquid, stock, it is very common that ESOPs do not provide for any kind of advanced distribution privileges beyond the minimum required by law. So, it is quite possible that the assets will be tied up for many years. The QDRO cannot require a distribution option that is not available under the plan, other than the specific QDRO rules. Those rules permit the order to request benefits at the date the participant attains age 50, as if the participant terminated employment on that day, but many ESOPs include a 5 year wait before a terminated participant can commence receiving distributions - hence the reference to age 55. So it is very possible that your friend will have to wait. The DOL provides some good information on QDROs at http://www.dol.gov/ebsa/faqs/faq_qdro.html

Interesting that you have a number of clients struggling with this issue. I think it is the kind of thing we always have struggled with and will continue to do so - when does something lose its attributes of bona fide? I suspect that 20/20 hindsight will apply, if the only folks who do this are high paids who are looking at everyway they can find to defer income - trouble. If there is a fair cross section (another one of those phrases we struggle with) then maybe the client is o.k. Good luck with your struggles.

Well, consider Rev. Rul. 96-47 and the significant detriment theory. In this case, the suggestion apparently is to deny former employees the right to share in any earnings. To me, that seems to be a significant detriment.

I do not think that this can be done if there is any substantial time passed from the annuity start date to the actual distribution date. (I find it odd that an ESOP uses the concept annuity start date, too....). It may be that the drafter was simply trying to avoid anyone saying that balances should be recalculated from the anniversary date to the distribution date, which frequently is several months later for an ESOP. But, if there is any risk that an anniversary date would intervene between the annuity start date and the actual distribution date, I know of no authority for any plan, including an ESOP, to freeze values in this way. If they want to eliminate the participant from the risk of changes in share price, they should explore their options for converting the stock into other assets, pending distribution. The government is also somewhat touchy about this action, but I think it can be done without violating the Code or ERISA, if you pay attention to protecting the rights of the participant. We should wait to see if RLL chimes in and tells me I am all wet.

You might consider doing a search through PLRs on this topic. I realize that you cannot rely on a PLR, but the logic that the government applies in reaching a holding will give you insight, since otherwise there is very little guidance on this rule.

See IRC Section 419(a)(2) - "if they would otherwise be deductible, shall (subject to the limitation of subsection (b)) be deductible under this section for the taxable year in which paid."

Leveraged ESOPs have two special rules for 415 limitations also. For a C corporation, if no more than 1/3 of the allocations go to the HCEs, interests and forfeitures of shares associated with this loan are disregarded. See IRC 415©(6). See Reg. 1.415©-1(f) for guidance on this and on the special rule for measuring the annual addition by the lesser of the employer contribution or the FMV of the shares allocated.

I think the conclusion is different than you propose. The Trust is the employer only for purposes of the transmittal of the taxes. For purposes of the determination of the FICA, we look at the actual employer. See GCM 38441 and, the IRS's analysis of this requirement in PLRs 200108010 and 199952048. These dealt with VEBAs, but it is the same issue - a trust making compensatory payments on behalf of the actual employer.