BeckyMiller

I would check with counsel who drafted the document to see what was intended. It is common to see shares allocated back based upon the ratio of debt service paid with allocated dividends to total debt service. Then, if some additional amount is required later to satisfy the return for value rule, that amount can be added to the participant accounts to make sure that they received shares whose value was at least equal to the dollar value of the dividends used for debt service. The timing of diversification is always a problem for privately held ESOPs. It seems that the appraisal process is getting faster, but rarely is all the work done in time to actually do diversification in accordance with the timing set by the statute. Do your best - get notices out based upon the best information available and let the participants know that these are estimated numbers. Then execute their direction based upon the final numbers. If there is a big difference between the estimates and the final numbers, the client should check with counsel to see if they should update the participant instructions.

Ah - I bet this is a private company whose shares include some kind of general restriction on transfer so they don't get in trouble with securities law issues. If you look at IRC Reg. 54.4975-11 you will not see any prohibition for these stock legends that have these kinds of restrictions on them that apply to all shareholders inside or outside the ESOP. BUT, I am guessing here, so I suggest that you talk to the client or their counsel to determine the nature of the transfer restriction.

I do not know of any statutory authority for such a call option. You are correct, the participants would have a put option. The IRS has ruled that there can be an immediate demand for redemption of the stock upon distribution by an ESOP of an S corporation - see Rev. Proc. 2004-4 and 2003-23. But this is an IMMEDIATE demand for redemption upon distribution, not one where the plan sponsor gets to choose when it feels like demanding the stock.

Interesting. This is only the second time that I have heard of this happening. Hope it is not an indicator of things to come. I suggest that you protest the IRS conclusion that it is a PT under the legal argument that the ACTUAL share release is controlled by the terms of the loan agreement (presumably those terms are appropriate), that the calculation was simply a clerical error which has nothing to do with the contractual release of the shares, when recognized the calculations were corrected to correspond to the documents appropriate terms. There is only one court case that I have found that even mentions this matter. See , NATIONAL HEALTH CORP. (Plaintiff) v. UNITED STATES OF AMERICA(Defendant), (Mar. 23, 2004) IN THE UNITED STATES DISTRICT COURT FOR THE MIDDLE DISTRICT OF TENNESSEE NASHVILLE DIVISION Mar. 23, 2004. But, the holding doesn't really answer the question - it goes to a purely procedural matter. The IRS required the taxpayer to pay the excise tax and they filed a refund claim. The IRS attempted to block the refund claim and the court overruled that attempt. But, I don't know if the company was successful in getting the refund or not. It would be helpful to this community if you could keep us up to date on developments on this. Good luck - Becky

Nope - the principal only method restriction on term at 10 years was in the original ESOP regulations which came out in final form in the late 1970s - I think it was 1977, but might have been 1978.

In what context have you encountered the term "nontransferable?" That would help in answering your question. When it comes to the ESOP's holding of stock, the shares are plan assets subject to the general rules for plan assets. If the plan permits distributions in stock and the stock is not publicly traded, the participant gets a put option to the company. The company may impose a very limited right of first refusal on the participant. For publicly traded securities on an active market, the stock would have no restrictions upon distribution for most participants.

Richard - I have never negotiated the excise tax on this situation, but I have seen many instances where the government was willing to treat it as a clerical error requiring correction in the participant accounting and not a prohibited transaction. These were all situations where the loan documents were correct, it was just the calculation of the shares where the error occurred. As long as the participant accounting was redone back to the date of the error and no participant was, in fact, harmed, they would drop the issue. Have they already written it up as a PT? Was the client unable or unwilling to correct the participant accounting?

Thanks!!! I figured that there was probably an exception there. I was hoping someone else knew where it was. Team Work is always the best way to accomplish anything. This is a great example of why the benefit plan world is so challenging - the income tax rules get turned sideways. So to MarZDoates, you are back to your original question. And as Belgarath notes, the traditional answers. What does the plan document say? Check with counsel.

I am curious about the nature of the error. Generally an error in the preparation of a Form 1099 for a plan distribution would not rise to the level of a fiduciary breach. If the participant has received his or her benefit from the plan, you can't sue the plan for anything. You got from the plan what was due to you. As to suing the fiduciary, it would have to be the party responsible for preparing the Forms 1099 or who was responsible but delegated that work to another group - payroll service provider, TPA, accountant or whatever. But, I just have a hard time seeing where the preparation of the tax report would create any kind of an ERISA claim. HOWEVER, I am not an attorney - just a CPA. Now, as to getting out of the penalty - it is generally pretty easy to get out of penalties based upon an error in the preparation of a Form 1099 over which the taxpayer had no knowledge or control. To the extent that you owe taxes and interest that is different. Also, to the extent it is the premature distribution penalty tax, there is no room for negotiation, but if it is the late payment penalty, you should be able to negotiate out of it if you can demonstrate that you reasonably relied upon the Form 1099 that was prepared by another party. Emphasis on reasonably relied. If you got a check for $12,000, for example and the Form 1099 said $1,200, they are less likely to let you off the hook. They would say that you should know what you got. So - lots of miscellaneous information - we can be more specific if you are willing to provide more specific information.

I would do some research about whether or not you are a controlled group yet. The rules under Section 414 of the Code start out with the rules under Section 1563. Under Section 1563, the determination of controlled group status is based upon the status of the group as of December 31 and the year including such December 31. But, if an entity would be considered part of the group for fewer than half the days of the applicable accounting period, then they are an excluded member. See IRC Reg. 1.1563-1T(b)(2)(ii). I don't know how this rule interacts with the 414 rules - never had to look it up. I know that there are several exceptions contained in 414 for some of the 1563 rules, but I just have never bumped into an exception for this one because I have never looked. Good luck.

One of the common misconceptions is that the audited financial statements are the responsibility of the auditor. In fact, they are the responsibility of management or the Plan Administrator in the context of an ERISA plan. The auditor is supposed to be auditing all of the information - the numbers, the classification and the disclosures. The only item that is really owned by the auditor is the auditor's report / opinion as attached to the front of the financial statements. Having said that the benefit plan community needs to understand that there are in fact a ton of new statements on auditing standards (SASs) coming out that do apply to benefit plan audits. There are a bunch of risk assessment standards, SAS 112 on reporting weaknesses and SAS 114 on communicating in writing with the appropriate governing body of the plan. It is somewhat controversial whether the plan's management must actually prepare the financial statements (that is required of an plan filing Form 11-k) or does the plan's management merely have to have the skills to be able to do this and have prepared and taken responsibility for the underlying financial records that support the formal financial statements. The audit community is working its way through the parameters of this statement at this time, so you are likely to see some different interpretations coming through. The point about manual adjustments to calculations is a bit fastidious, but it goes to the integrity of the database - how does the auditor get comfortable that the issues corrected on the statement have been addressed in the system so that they do not crop up for other participants. Retyping, though, shouldn't be the solution - I would look at a system enhancement, review steps, etc. Go to the AICPA Audit Quality Center at http://ebpaqc.aicpa.org for more information on developments in this area.

Potentially - you need to look at liquidity needs, potential unrelated business income tax if it is debt-financed property or leased property, prohibited transaction implications, etc. Lots of technical stuff. Obviously, diversification is generally a good idea, but with one person plans - presumably the owner - the plan's portfolio has to be examined in light of the owner / participant's aggregated investment portfolio.

An in-kind contribution to a retirement plan is a fairly common occurrence. The contribution of stock to a 401(k), profit sharing, stock bonus or ESOP is probably the most common form of the in-kind contribution. You just need to make sure it is done in a manner consistent with your plan agreement and is properly valued. The controversy in the early 90's related to whether or not the event was a prohibited transaction - transfer of property to satisfy an obligation. This is one of those areas where you have to rely on the fact that there is nothing that prohibits an in-kind contribution and take it from there. (This contasts, for example, with the IRA rules where the law specifically prohibits in-kind contributions.)

Synthetic equity can be a huge problem if you have only one owner. Status as a disqualified person is based upon both the ESOP AND any synthetic equity. You can limit ESOP allocations and still have a disqualified person because of synthetic equity. If your controlling owner is that disqualified person, you are very likely to fail the 50 percent broadly held standard. At which point life ceases to exist as we know it. Good luck - Becky

A disregarded LLC, more properly a "disregarded entity" is a limited liability company that is wholly owned by another person or enterprise. See §301.7701-2(a). The separate nature of the entity is disregarded for all purposes of the tax code - so for 401(a) purposes, this is not an aggregated payroll, any employees of the disregarded entity are treated exactly the same as employees of owning entity. But, this is legal fiction for the tax code only. It may still be a separate entity for other business purposes.

It seems like we all agree that this particular deal isn't attractive. But, we didn't seem to agree on the answer to the aggregation issue. Section 1563 clearly ignores stock held by a 401(a) plan in the calculations of control and in attribution. But Section 414(b) says that determining the members of a controlled group of corporations under Section 414(b), we start out with Section 1563, except: "section 1563(e)(3)© (relating to stock owned by certain employees' trusts) shall not apply." This is the provision that excludes stock held by a retirement plan from attribution under the general rules of attribution out of trusts. I have always understood this to mean that for 414(b), one did attribute stock out to the ESOP beneficiaries to the extent that such stock was allocated to their accounts under the general rule Section 1563(e)(3)(A) - 5 percent owners only. Shares held as collateral would not be attributed to anyone. This is kind of a weird provision, as there is no change in the determination of a controlled group member under Section 1563(b) - so stock held by a 401(a) plan is still excluded from the denominator. But, theoritically, if I had someone who owned before attribution 79% of an ESOP company and 100 percent of another corporation, if that person had 5 or more percent of the beneficial ownership of the ESOP, they would be attributed out their ESOP stock. It is not clear that this attribution would count for increasing both the denominator and the numerator in the calculation, but if I am somewhere close to right, they could end up a controlled group under 414 and not one under 1563. Thoughts?

Not a problem - communicating in this format is easy to mess up. I was as concerned that I was stating this in a manner that was understood... Becky

415 Final regulations were issued last Friday. So - anyone holding their breath yet for the 409A regulations?

Well, I agree with the results that "A Shot in the Dark" suggests, but not why. A profit sharing plan is a permissible shareholder in an S Corporation. Per Section 1361( c )(6) - any 401(a) plan can be a shareholder of an S corporation. BUT, only ESOPs are exempt from the associated unrelated business income tax on the trust's share of any pass-through income. Also, for such a shareholder, unrelated business taxable income includes both the pass-through income and any gain or loss on any disposition of the stock. According to the Blue Book, this includes the distribution of shares to a participant as part of the plan's normal operation. SO - though permissible, it may not be a wise economic decision (did someone say "fiduciary conduct?") to put S corporation stock into a profit sharing plan.

The Courts are pretty firm that employer's cannot escape ERISA by simply making oral promises, rather than putting them in writing. See for example - Moeller v. Bertrang (DC SD, 8/24/92) 1469 or Hollingshead v. Burford Equipment Co. 747 FSupp. 1421, 1434 (M.D. Ala. 1990), 809 F. Supp. 906 (M.D. Ala. 1992).

Just to help. The actual citation is §1.219-2(d)(1) Definition of active participant Here the regulations provide: This paragraph applies to profit-sharing and stock bonus plans. An individual is an active participant in such plans in a taxable year if a forfeiture is allocated to his account as of a date in such taxable year. An individual is also an active participant in a taxable year in such plans if an employer contribution is added to the participant's account in such taxable year. A contribution is added to a participant's account as of the later of the following two dates: the date the contribution is made or the date as of which it is allocated. Thus, if a contribution is made in an individual's taxable year 2 and allocated as of a date in individual's taxable year 1, the later of the relevant dates is the date the contribution is made. Consequently, the individual is an active participant in year 2 but not in year 1 as a result of that contribution.

Just to clarify for Christopher. ESOPs do not qualify for any of the safe harbors. They can have allocation formulas that are based on something other than simple compensation to compensation. It is just that they have to be tested for nondiscrimination without the benefit of any safe harbor or permitted disparity.

Hmmm... I do not know the mechanics. But, under the Revenue Procedure that defines the rules for an S corporation to run on a fiscal year, it makes a specific statement that the enterprise can report on the same fiscal year as a 100 percent ESOP shareholder. So, I would be sorely tempted to file a final deposit form and ask for a refund of tax citing the applicable language from the revenue procedure. See Rev. Proc. 2002-38.

I do not see any reason why this would be a distribution. The IRA is a taxable entity in this case, the cash was used to pay the IRA's tax liability. It is of no benefit to the IRA participant. The IRA is not a pass-through entity paying this tax on behalf of the participant. It is the IRA's tax, not the participants. Gosh - I am just saying the same thing over and over.... Sorry.

Hmmm... The regulations at 1.404(a)-9(b) are really old for purposes of this question. There are two PLRs that give some insight into the language of the regulation - see PLRs 9635045 and 199909060. But, I think in today's world, where employee salary deferrals are no longer treated as employer contributions for the deduction rules, your concern is justified. Are you really calculating the limit for two plans, when under your facts, really only one plan is limited. I personnally would not feel comfortable relying on the conclusions that you can combine the limits when making a truly tiny employer contribution to the 401(k) plan. If it is a big deal, I would check with legal counsel or an experienced tax accountant who will really look things up and give your client something that they can rely on.