Marcus R Piquet

You might also want to ask about whether a discount for lack of control should be applied to the non-ESOP shareholder transactions. The ESOP trust owns a control position, and presumably the shares being sold by the non-ESOP shareholders might be worth less.

Pardon the obvious question - but if your family owns that much of the bank, why aren't you on the Board? Also, does the ESOP allow for distributions in the form of stock (rather than cash)? If so then I don't see why that wouldn't work - several specialized IRA custodians will accept non publicly traded stock.

So sorry for your difficulty. I agree that the company must be struggling, and if I were you I'd be worried if you'll ever get paid at all (in the event of a total business failure). I'd suggest you mail a Claim for Benefits in writing, preferably by mail, certified, and with return receipt requested. By law they will need to respond to you with a specific denial of benefits, which you can appeal. This will help you build a case. If you want to play hardball you can also request an in-person meeting, and threaten to contact the DOL if your meeting request isn't honored. You should also request the most recent SPD, along with any SMMs thereto, and to review a copy of the current distribution policy. They may be relying on the financed securities exception to explain the open-ended delay. If so, you should ask when the loan(s) is scheduled to repaid so that the exception will expire. Good luck to you and to Hobbico. I hope they can turn things around.

I've heard of plenty of pushback from Cincinnati when this is left as purely discretionary due to the "definite written plan" principle. While the anti-cutback exception clearly allows for changes here, in my opinion it should be done through plan amendment or revision to the distribution policy (which should be explicitly incorporated by reference in the plan doc).

I take a minority view that it generally makes no sense for an ESOP that already owns 100% of the stock to buy more. The employer can continue to provide a stock benefit through recycling or simply contributing additional shares. That said, I don't see how this would be a solution to your problem anyway. The obvious solution seems to be a loan write-down as was already suggested. This would solve your 404 issues. For some guidance on this, you can read PLR's 8612081, 9447057, and 9237037.

Thanks QDROphile.

I have a client who is considering using the ESOP for safe harbor matching contributions. Other clients have used their ESOPs for safe harbor nonelective contributions, but I don't yet have a non-KSOP making matching contributions in the stand-alone ESOP. The regs show that this is permissible. §1.401(k)-3(h)(4): "Safe harbor matching or nonelective contributions may be made to the plan that contains the cash or deferred arrangement or to another defined contribution plan that satisfies section 401(a) or 403(a). . ." The ASPPA DC-2 book states, however, "If this option is used [i.e., contribution to a different DC plan] it will typically involve the safe harbor nonelective contribution." (as opposed to the safe harbor matching). My experience so far lines up with the comment in the DC-2 book. But why is that? Shouldn't be very difficult to calculate the proper match based on the 401(k) deferrals, and designate that portion of the ESOP contributions accordingly. Obviously there are other issues to deal with, but do any of you have any experience about why a safe harbor match might be a bad idea as opposed to a safe harbor nonelective? Thanks! Marcus

Here's an easy one. The loan agreement stipulates that loan prepayments are applied to the front end of the loan instead of the back end. If the loan is prepaid, you essentially have a payment "holiday" until you catch up to the original amortization schedule.

Not only that, if the missed distribution would have been paid at a higher value if it had been paid timely, you ought to pay that missed installment at the higher value.

See Rev. Proc. 2006-46. One of the automatically-approved tax years for an S Corporation (under the "sufficient business purpose" category is the "ownership taxable year." Section 5.06 of the Rev Proc defines a Permitted Taxable Year as 1) the required taxable year (i.e., December 31); 2) a natural business year, 3) the ownership taxable year; 4) a tax year elected under §444 (i.e., September, October, or November, with an annual deposit requirement); or 5) any other taxable year for which the taxpayer establishes a business purpose to the satisfaction of the Commissioner. Section 5.08 of the Rev Proc defines an Ownership Taxable Year as follows: For an S corporation or electing S corporation, an "ownership taxable year" is the taxable year (if any) that, as of the first day of the first effective year, constitutes the taxable year of one or more shareholders (including any shareholder that concurrently changes to such taxable year) holding more than 50-percent of the corporation's issued and outstanding shares of stock. Under principles similar to §1.706-1(b)(5) for determining the taxable year of a partnership, a shareholder that is tax-exempt under §501(a) is disregarded if such shareholder is not subject to tax on any income attributable to the S corporation. Tax-exempt shareholders are not disregarded, however, if the S corporation is wholly-owned by such tax-exempt entities. An ESOP is a tax-exempt entity under §501(a). If it owns anything less than 100%, its ownership is disregarded for purposes of defining the ownership tax year. However, if it owns 100%, then its ownership is not disregarded. The S corporation can therefore retain the ESOP's tax year end, no matter what month that is. No annual deposit under §444 is required. We have dozens of S Corp ESOP clients with non-calendar year ends under this provision, so I know it works. One word of caution. In almost 50% of the cases that we've done this, the IRS does not correctly process the Form 2553 and automatically assigns a Calendar year end. This is a simple oversight on their end since the use of this provision is so extremely rare in their eyes. In all cases I've been able to simply place a call to the entities division in Ogden and have the situation corrected over the phone, with a corrected notice sent to the client shortly thereafter indicating the desired year end. Good luck! Marcus

Some do not realize that if the ESOP owns 100% of the outstanding shares it is not necessary for the sponsor to change to a calendar year end. It is permitted to retain the year end of its sole shareholder. This only works in a 100% ESOP ownership scenario.

Sure - here you go. Not an easy case to find, and, so far as I'm aware, the only one that addresses the issue of whether inserting a delay into your distribution policy results in a cutback under §411(d)(6). Marcus Lee v. Builder's Supply ESOP - 411(d)(6)(C) anti-cutback, timing.pdf

I agree with ESOP Guy with respect to 415. If you want to read up on it, see §415©(2), Regs 1.415-6(b)(2), CB Notice 2002-2 Q&A 6, and PLR 200243055. It's nearly universally accepted that dividends paid on unallocated shares must be currently allocated to participants (or passed through). I recently helped a client go through a VCP filing because they had neglected to allocate these dividends to participant accounts but simply held them in "suspense" along with the shares to which they relate. I know of one ESOP attorney with a contrary opinion, who believes that these dividends should be able to be held in suspense, and allocated to participants when the corresponding shares are released and allocated. Let me know if you want me to put you in touch with him.

Belgarath, I've seen it done both ways, and I've also seen plenty of plan documents that aren't explicit on this point. If you allocate the accrued contribution as cash/OIA, then you'll need a rebalancing/reshuffling transaction in 2013 to replace the accrued cash with the released shares. If you allocate the accrued contribution in the form of the committed-to-be-relesed shares, then you avoid the rebalancing transaction in the following year. Where there is the ability to exercise discretion, I typically suggest the latter approach for two reasons: 1) Easier for participants to understand - avoids the need to explain a rebalancing/reshuffling transaction; and 2) It mirrors the GAAP concept of doing this on an accrual basis from the sponsor's financial reporting perspective. Your 3,000 shares would be disclosed by the sponsor as "committed-to-be-released shares" in their ESOP footnote disclosure. Review SOP 93-6 / FASB ASC 718-40. Good luck!

Hello, TPS. Excellent question! I spoke to FinCEN, the division of the Department of the Treasury with authority over the FBAR (Form TD F 90-22.1). The agent and I read through the relevant regulation together (31 CFR 1010.350, see http://www.law.cornell.edu/cfr/text/31/1010.350). Our joint interpretation: 1) An ESOP trust qualifies as a "United States person" under §(b)(3) of the regs. There is no exemption for qualified retirement plan trusts. 2) A reportable "financial interest" by a "United States person" includes the ownership of more than 50% of the stock of a corporation under §(e)(2)(ii) of the regulation. Accordingly, if the ESOP-sponsoring corporation has an FBAR filing requirement, and the ESOP owns a controlling interest in the corporation, the ESOP trust also has an FBAR filing requirement. I put a call into the IRS also to see what they say. Otherwise we have five business days to take care of this for the 2012 calendar year.

Allow me to clarify - are you asking if prior years' contributions of cash that were NOT originally designated as debt-service contributions at the time of contribution can be used to make payments on the exempt loan?

The other reason I prefer the term "dividends" in the context of ESOPs (whether it's a C Corp or an S Corp) is because some of my clients confuse S-corp distributions with distributions of benefits to the terminated participants. Seems easier to just call them dividends (which they are) and avoid the confusion. Sorry to get off-topic.

I agree, it's always better to decide upon the character of the funds at the time of the transfer. Usually you can estimate this in advance. Sometimes not. ESOP Guy - I can't help myself so please forgive me. S Corporations do pay dividends. State corporate law makes no distinction between C corps and S corps - they all pay dividends. The Internal Revenue Code calls dividends paid by S Corporations "distributions of earnings," true, but even the concept of S Corporations is a tax code concept and has nothing to do with corporate law. You'll find that the financial statements of most S Corps company call them dividends, not distributions. Again, sorry, just a pet peave of mine.

DPL, Feel free to call me if you like, or have your CPA call me. First question - what does the share release have to do with SOP 93-6, now codified as FASB ASC 718-40? Two things come to mind: 1) Measuring compensation expense on the company's P&L; 2) Measuring Unearned ESOP Shares on the company's balance sheet. For the first issue, see FASB ASC 718-40-30-2: "the employer shall recognize compensation cost equal to the fair value of shares committed to be released." The actual release of shares is controlled by the pledge agreement, so if the pledge agreement clearly specifies a principal-and-interest share release method, and if that is the way the shares are, in actuality, being released and allocated to participants, then it is clear that that same number of shares should be used for expense recognition. To use a different number of shares to measure compensation expense simply makes no sense. For the second issue, see FASB ASC 718-40-30-3: "Unearned employee stock ownership plan shares shall be credited as shares are committed to be released based on the cost of shares to the employee stock ownership plan." In other words, Unearned ESOP Shares should be reduced by the cost of the actual number of released shares, not some alternate calculation of released shares that is not what is actually happening within the trust. The two different share release methodologies (i.e., principal-only or principal-and-interest) aren't even described in SOP 93-6, so SOP 93-6 clearly doesn't control the use of either approach for anything related to the financial statements. That is controlled, again, by the pledge agreement on a loan-by-loan basis. SOP 93-6 should reflect the reality of what is happening within the trust, not some alternate universe. Thanks, Marcus

The company can certainly supplement the annual contributions with dividends. Those dividends, in turn, can be used by the ESOP to make payments on the exempt loan with the significant caveat that the "FMV rule" of IRC §4975(f)(7) is met. If there are problems with this "FMV rule" (based upon the value of stock allocated pursuant to dividends on allocated shares), then there are techniques might be used to modify the allocation of the shares so released. This is a pretty technical and nuanced area. To be frank, if this is not a subject that you are comfortable with you might want to consider taking a pass on the TPA work.

I don't have anything terribly helpful to say here other than the fact that I've never seen transactional fees paid out of plan assets nor heard anyone suggest that they could be. Given the amount of DOL scrutiny that ESOP stock acquisitions undergo already, I simply would not risk it.

Belgarath, What would normally happen in a situation like this is that the Board would terminate the ESOP, resulting in 100% vesting for all participants. The ESOP stock would be re-appraised at the end of this year, at which point the accounts would be re-valued to reflect the near-worthlessness of the ESOP stock. You would then proceed to make distributions as called for in the plan document and/or distribution policy. You may even amend the plan document or distribution policy to accelarate the timing of distributions in connection with the liquidation of the Plan. If there are participants that are due a distribution this year and you know their accounts are significantly overvalued, most plans contain a provision whereby the trustee or committee can declare an interim valuation date so that you could re-value the plan prior to paying out the current batch of distributions. This introduces added expense for an additional appraisal, but you could potentially distribute all of the ESOP's stock after obtaining that interim valuation and thereby eliminate the need for a year-end valuation. Does this get at the core of your question? Marcus

IRC §409(h)(1)(B): " . . . if the employer securities are not readily tradable on an established market, [participant] has a right to require that the employer repurchase employer securities under a fair valuation formula." Treasury Regs §54.4975-11(d)(5) clarifies: ". . . valuations must be made in good faith and based on all relevant factors for determining the fair market value of securities. . . . value must be determined as of the most recent valuation date under the plan. . . . a determination of fair market value based on at least an annual appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any party to a transaction under §54.4975-7(b)(9) and 12) will be deemed to be a good faith determination of value." GAAP book net value and fair market value are two completely different things. Also remember that if a promissory note is given in exchange for redeemed/put shares, the note must be adequately secured. Per IRC §409(h)(5): If an employer is required to repurchase employer securities which are distributed to the employee as part of a total distribution, the requirements . . . shall be treated as met if - (A) the amount to be paid for the employer securities is paid in substantially equal periodic payments (not less frequently than annually) over a period beginning not later than 30 days after the exercise of the put option . . . and not exceeding 5 years, and (B) there is adequate security provided and reasonable interest paid on the unpaid amounts . . ." Usually an insolvent company is going to have a hard time providing adequate security.

Since nobody has answered yet, I'll throw my hat in the ring. IRC §411(d)(6) prohibits a reduction in any "accrued benefit" by plan amendment, including the elmination of an "optional form of benefit." However, §411(d)(6)© provides a special rule for ESOPs - ESOPs are permitted to "modify distribution options in a nondiscriminatory manner." Treasury Regs §1.411(d)-4 Q&A 2(d) exapnds on the ESOP exceptions as the following: - Single sum vs. installment optional forms of benefit; - Cash instead of stock if the company becomes substantially employee-owned or becomes an S corporation; - Stock instead of cash if the comany becomes readily tradable; or - Cash instead of stock if the company ceases to be readily tradable. It would appear that your first concern is addressed in the first exception. Your second concern deals with inserting a delay, up to the limit imposed by §409(o). This is more contraversial as it doesn't appear to be one of the specifically-enumerated items in the regulation. I've heard arguments on both side of this one, so I try to avoid it where I can by carefully crafting the distribution policy for accelerated timing to apply only to certain groups (e.g., small account balance or a limited-time offer window period distribution). If you're really interested in this, there is one court case I am aware of that supports the insertion of a delay - Lee v. The Builder's Supply ESOP, a 1995 case in Nebraska district court. The basic logic is that the delay falls within the first exception because one installment optional form of benefit which begins on an accelerated basis is replaced with another optional form of benefit which is delayed for six years. I'll send you a copy of the ruling if you need it.

Wow, I've got to say that I think ERISAtoolkit.com appears to be way off-base here. What rhkesop seems to be describing is, sadly, not that uncommon of a situation. Allow me to present the perspective of the Company in all of this: - A company establishes an ESOP in good faith with the goal of using it to buy out an owner. - Rather than doing a completely leveraged ESOP transaction, the Company plans to prudently "pre-fund" for the anticipated ESOP transaction by making contributions to the plan for a few years. - Most unfortunately, a couple years into this plan, the Company is unexpectedly severly impacted as a result of the worst recession in our lifetimes. The owner sees the value of his investment fall precipitously, perhaps as much as 40% to 90%. How excited to you think he is about the prospect of selling his Company to the stock when it is at an all-time low? - "Prefunding" within an ESOP for a future transaction is not at all uncommon. However, IRC §4975(e)(7) defines an ESOP, in part, as a plan which is "designed to invest primarily in qualifying employer securities" (see also §54.4975-11(b) ). This raises a difficult issue - clearly the ESOP is "designed" to ultimately be invested in employer securities, but how many years can the plan really go without actually acquiring employer securities before that "design" can be called into question? In my professional experience, we all start to get nervous about this after three to five years. In the case of the most severe recession of our lifetimes, would it be reasonable to stretch that out? Seven years? Ten? I'm not sure. ESOP Guy is spot-on here - what's the worse that could happen? The IRS could contend that the ESOP isn't really an ESOP but rather a profit-sharing plan. So what? That means that it would be more difficult (but not impossible) to use those funds in a future ESOP transaction. - Regarding the nature of the plan investments and the administrative costs of the plan - remember that the current owner(s) is hoping to receive these plan assets in the future as consideration for his/her shares in a future ESOP transaction. His interests are aligned with the plan's - he wants to protect that nest egg and grow it prudently if possible so that the funds will be there at transaction time. I suppose it's possible that he's just stupid and likes to give his money away to service providers, and yes, that could constitute a fiduciary breach, but I think it's unlikely. ESOP Guy is absolutely right. Talk to the employer first before talking to the government. I see no reason to assume that the employer is doing anything imprudent. To the contrary, it seems obvious that the owner is experiencing a lot more pain than the participants are. Getting the DOL involved prematurely probably wouldn't help anyone.