IRC401

The regulation cited above deals with "participant contributions", a term that is nowhere defined to include elective deferrals. After the regulation was issued, some attorney (Don't you wish that they wouldn't ask questions?) inquired whether participant contributions included elective deferrals. The Dol, ignoring both the law and the Administrative Procedure Act, responded that they did, and then issued a notice stating that it wouldn't enforce the trust requirement, which it shouldn't be able to enforce anyway. Assuming that the Administrative Proceedure Act is still good law (and I realize that the DoL tends to ignore it), the reg. doesn't apply to elective deferrals under section 125, and the DoL needs to go through the rulemaking process to change it.

I haven't heard of any actual litigation. I'm under the impression that there is something in the Medicare regs that supports the position that the government is entitled to part of the reversion. You need to find someone who is familiar with the Medicare rules. I have also heard that Defense contractors have a similar issue with the Department of Defense.

Have you checked with the major mutual fund families? Do they all have high minimums? (even Vanguard?) There is no requirement that you allow every employee to contribute up to the MEA limit. You can establish limits on what employees may contribute in order to avoid most problems. Now that elective deferrals count as compensation, the problem should be much less than in prior years.

403(B) assets may be invested in annuity contracts or mutual funds. If the assets are in a bank trust fund, you do not have a 403(B) plan. Because there is no need for a trustee for a 403(B) plan, I wonder what other kinds of problems you might have.

Just to clarify the record: - What I disparage is Deloitte's marketing of the idea. Deloitte is, in effect, using a bait and switch tactic. They discuss this idea as if it were a fixed price option and then sell the "unleveraged" variety without discussing any difference in risks. Deloitte has been marketing this idea for over three years, and your statement is the first admission that I've seen that the idea is aggressive. At one point Deloitte was (and may still be) using literature that uses the quote "not being risky" to describe the idea. (The same literature has misleading statements about bankruptcy law, estate planning, and FICA taxes and omits any mention of issues related to state taxation of nonresidents.) - As for Tom Brisendine, you missed the point of my comment. Brisendine is commenting on what Deloitte isn't selling. Therefore, I conclude that your firm is trying to hide something. (If you doubt the accuracy of my statements, please show the statistics regarding how the KeySOP sales break down by type.) Next time you talk to Tom, please feel free to discuss with him what he meant when he stated at an ALI-ABA program a couple of years ago that he was troubled by some of the discounted option products. - I do make a living rendering tax advice in the private sector, and I make it a point to try to consider all relevant tax issues before I sell an idea (or when I'm reviewing someone else's idea). The issue of form versus substance is hardly a novel issue.

Why would they want a 401(k) plan (as opposed to staying with the 403(B) plan) ?

Are prototype documents suitable for multiple employer plans? There may be changes that take effect immediately that have nothing to do with 410(B), such as the need to do separate ADP tests. You probably should decide what you want do do with the plan and get it amended or divided ASAP.

In my first message, I described four types of KeySOPs. In my opinion the first two kinds work. This message deals with the the last two kinds. I disagree with your description of the issue. The issue is whether a financial instrument must have economic substance as an option in order to be an option for purposes of section 83. There is no authority that resolves this issue. In my opinion: (1)the IRS reserved for itself in the section 83 regs the ability to apply a substance requirement, and (2) as a matter of public policy they should apply such a requirement or abandon the doctrine of constructive receipt. Is it good public policy to let wealthy people get around the doctrine of construcitve receipt by disquising what is clearly constructive receipt with embellishments that have no economic substance? If (and it is an if) an option must have economic substance, then the value of the option privilege must have a positive value. If the option privilege does not have a positive value, then the "option" would not make any economic sense outside of a plan of deferred compensation, and I think that it would be reasonable for the IRS to take the position that the product is, as a matter of economic reality (as opposed to form), a plan of deferred compensation. In the case of my variation 3 (for which you have no name although Deloitte has sold it) the discount percentage is irrelevant (do the arithmetic), and therefore, it is easy for me to take the position that the product is not an option regardless of whether the discount is 1% or 99%. Variation 4(which you call "unleveraged") is variation 3 with a risk (probably very small) of economic loss. It appears that you are making some sort of "haircut" argument that the potential for a loss is enough to make this an "option". I: (1) don't regard your position as being based on a logical interpretation of the regs (because I believe that you have assumed a solution to the biggest problem), (2)don't see how the KeySOP reduces estate tax exposure (have you checked with the estate tax specialists in National Tax), (3) agree with your "not free from doubt" statement (but my lack of clear authority does not mean that you have authority), and (4) think that the only kind of unleveraged KeySOP that would not subject the taxpayer to the "same risk of immediate taxation" is one that did not provide for a cashless exercise (and as far as I know D&T is not selling those).

PJK- I just spent 20 minutes typing a response to you, and aol logged me off for inactivity. The short version is: The development of D&T's variations had nothing to do with financial statements. People sold what I refer to variation 3 before it was reviewed by National Tax, and when objection (both internal and external) were raised National Tax created variation 4 rather than give back money. Variation 4 is virtually economically indistinquishable from variation 3, but it looks more like an option. You are selling camouflage. The reason why versions 3 and 4 are so popular (if they work) is that they are economically indistinquishable form constructive receipt without the adverse tax consequences. The 421 provisions you cite are obsolete, and because they are limits on floating exercise prices, I wonder if Congress regarded floating exercise prices as an abuse 60 years ago. See my question to Kirk re: the 83 regs. The Victorson case could (and probably should) be read as nothing more than that a taxpayer is bound by his choice of a form for a transaction but the IRS is not so bound. If Victorson had gone the other way it would have opened the door to abuseive situations. Deloitte is (or at least was) giving a "more likely than not" opinion on variation 4 (unleveraged), which means that it believes that there is a 49.99% chance of failure. If you were a VP in a private company with $100,000+ of deferred comp would you want a traditional plan with 30+ years of IRS rulings behind it, or the "unleveraged" plan with a 49.99% chance of immediate taxation?

Kirk- It is a classic form v. substance issue. The issue is whether a product is an option for purposes of section 83 solely on the basis of form. Suppose an employer granted an employee a fixed price option to purchase 1500 units of a mutual fund (with a $1/sh price) for $1000. It looks like an option, but suppose I add that the fund is a money market fund. Can you really have an option (within the meaning of section 83) to purchase a cash equivalent? If not, then substance must have some role to play. Variation 3 is the economic equivalent of offering an employee the right to take deferred comp equal to the value of 700 units of his favorite mutual fund at any time that he wants plus the opportunity to purchase (with his own after-tax dollars) 300 units of the same mutual fund at the price that the fund sponsor is selling the fund to the public. In variation 4 the employee has the opportunity to purchase the 300 units at a price that will almost certainly be the same as the public price but could in theory be higher. The value of the option privilege (or Black-Scholes value)for variation 3 is zero. For variation 4 the Black-Scholes value is negative (although it is probably zero when rounded to the nearest dollar). Therefore, variations 3 and 4 simply do not and would not exist outside of a plan of deferred compensation. They have no substance as options; they merely look like options. Check reg 1.83-3 and ask yourself whether the IRS reserved for itself the ability to recharacterize a transaction based on the facts and circumstances. Variations 3 and 4 are economically indistinquishable from construcitve receipt, and the IRS should either kill those variations or abandon the doctrine of constructive receipt.

WARNING: There are four basic variations of the KeySOP, depending on the exercise price: 1. Fixed exercise price 2. Indexed or increasing exercise price (The price starts at a fixed percentage of the exercise price at the date of grant and increases each year by either a fixed or variable interest rate.) 3. Floating exercise price (exercise price is a percentage of FMV at date of exercise.) 4. "Greater of" (greater of percentage at date of grant or date of exercise) There is an issue whether the last two varieties are in fact options. The issue is whether you can get around the doctrine of constructive receipt by putting the word "option" on a sheet of paper and concluding that you have an option. The IRS should have authority under the section 83 regs to recharacterize the transaction as a deferred compensation arrangement. Brisendine and Veal have an article in a recent edition of the Journal of Deferred Compensation that discusses discounted options. They skillfully discuss the first two varities and ignore the last two. It is the last two that Deloitte is selling. IMHO the benefits of a KeySOP for an executive of a for-profit entity are marginal, and the risks are substantial. Tax-exempt enetities have a different situation because of 457(f), but they still need to understand what they are buying.

I see two possilbe problems: 1. If (A) you are using a general test, and(B) you use the active rate for the (a)(4)calculation, a participant who terminated could argue that at the time the test was run he earned an accrued benefit which included the active interest rate until the testing age, and reducing the interest rate upon termination is an impermissible reduction in his accrued benefit. 2. For lump-sum calculations, don't you need to project "accounts" forward using the plan interest rate and then discount back using the GATT rate. It seems to me that you could end up with some screwy results.

Question: Is a VEBA established by a government tax exempt under IRC 115, or as a separte legal entity does it need to be tax exempt under another Code section? If its sole tax exempt status is under 501©(9), wouldn't the trust be subject to the tax on UBTI (making it imprudent to use a VEBA)?

vebaguru- Why is that the real question? Doesn't IRC 4976 apply to the trust regardless of whether the trust is taxable?

The discussion has focused on retirees. If someone terminates at age 30, do you want to hold on to his money for 35 years and then pay him a piddling annuity?

RLL- We can speculate all we want on the facts. Nevertheless, I find it hard to believe that there would be a 411(d)(6) problem. All they have to do to avoid a problem, is not be discriminatory.

It appears to be a 409(h)(5) issue (and it would certainly be helpful to have all of the facts), and you are correct that the 1987 cut-off date is important. If the plan is going to start distributing shares and reacquiring them, it will have to deal with 401(a)(28) in the future. I don't see how it could be a 409(O) issue. They could spread the payout over five years, but they would have to credit market investment results each year unless someone has figured out how to create a cash-balance ESOP.

Also keep in mind that employees who are 55 and have ten years of participation have the right to invest part of their accounts in something other than employer stock. Make certain that you understand all of the rules.

If the employer is under no obligation to make contributions, why can't it just stop contributing and foreclose on the loan (assuming that the ESOP doesn't hold a majority of the voting rights)?

Deloitte & Touche has been telling large publicly traded companies to merge all or part of their 401(k) plans into ESOPs for years (although they are interested in the part of the 401(k) plan already invested in employer stock). I doubt that you have any qualification problems, but you do have fiduciary issues and securities law issues. I also doubt whether hiring an independent fiduciary makes much of a difference. If the stock tanks (or even significantly underperforms the 401(k) plan), be prepared for a class action suit. Could the client get to where it wants to be by making future matching contributions in employer stock?

To me, lots of hand holding and low cost are inconsistent objectives (although you can make it low cost to the employer by subjecting the employees to lots of asset based fees). I suggest that you take a look at the plan design and try to determine if you have bells and whistles that you don't need or have plan design features that unnecessarily complicate plan administration. My experience has been that the people best able to respond to RFPs are the ones least able to give good consulting advice. Why don't you consider where you would like to invest the plan's assets, and see if you can work out an acceptable arrangement with the investment organization. Finally, beware of packaged deals. Organizations that charge asset based fees will often throw in a plan document for little or no cost. A poorly designed plan document can come back to haunt you later. Good Luck.

One of the excuses that my former employer had for not wanting to give out the plan document was that the HR people didn't want employees asking for explanations of what the document meant. Even though I gave tax advice on retirement plans for a living, they were afraid that I was going to ask for an explanation of the top-heavy rules for a plan that covered thousands of employees. [They did send me a copy of the plan.]

I hope that you saved a copy of your summary plan description (SPD)from the Rockwell plan. Take the SPDs from the Rockwell and Boeing plans to a local actuary and ask him to do a comaprison for you.

Sorry, but I respond from home and don't have my research files here. I'm not certain whether the IRS issued a PLR or a TAM. In either case it is non-binding (and was issued a number of years ago).

I'm not certain if the "you" in your message was addressed to me or the original poster. My comment on the IRS' position was with regard to a choice offered outside of a 125 (or 401(k) or 403(B)) plan (what you would refer to as the first choice). The country CPA may be correct, but the IRS has issued a nonbinding opinion contrary to what the CPA is recommending. The CPA doesn't score until he discloses the IRS' position, discloses the litigation risks, and gives an explaination as to why the IRS is wrong.