ESOP Guy

TPApril: While it is true that money put into an ESOP to provide liquidity for distributions can be a contribution, it could be a dividend paid on the stock for example. Not all money going into an ESOP to fund a distribution is a contribution. I believe that you are making an apples to oranges comparison in this case. No one would call money going into an ESOP to fund distributions as a reimbursement. One could look at this way. The ESOP sponsor could put money into the ESOP, via contributions, even if there are no distributions and then years later when there are distributions you use that cash to make the payment. There is a buy/sell between the participants that is going on. My point is regardless if the cash addition/distribution happens in the same year of different years the accounting requires some people to get an increase in shares in exchange for some portion of the cash in their account. The expense example is different. The times I have seen this happen the full intent of the sponsor was to pay 100% of the expenses for everyone. I realize intent and legal isn’t the same thing. In this case the transaction doesn’t require a change in anyone’s account. The money can come and go and no one’s account would have to change. With the ESOP distribution example most if not everyone’s account will change in some manner. Either they are selling cash and buying shares, or they are the person being paid from the ESOP. So while on the whole the nothing changes in the ESOP, the cash went in and the cash went out—that nets to zero on the whole, within the group the details have changed. In the ESOP example the shares staying in the trust have to be spread to everyone who has cash in their account. How any given account gets cash is independent of the distribution (payment). In the case of the expense reimbursement the cash is being put in because there is an expense to be paid, and the employer does not want the employee accounts to take a hit. Like I said I have never seen cut and dry guidance on this, but I think my position is reasonable. And one of the things I have found over the years is when you are reasonable and treating the NHCEs fair when the rules isn’t clear, the IRS give one a lot of slack.

Lou: Unless the company is just determined to merge mid-year I would suggest doing the merge at 1/1/2012. I believe, someone please confirm this, the rules that give you a grace period for coverage testing extend to the ADP/ACP test with purchases. I am doing this from memory. It has been a very long time since I merged two 401(k) plans, but I would look into that if you think the company is willing to merge as of 1/1/2012. I am very willing to be told I am wrong about the grace period for company purchases extending to the ADP/ACP testing, but that is my memory. (Ok, can I hedge my advice any more then I have?) I can’t imagine the cost of merging at 1/1/2012 is much difference then 9/2011.

I don’t believe there is a place one can point to for official guidance. I never count employer reimbursements of fees as contributions. I don’t show them coming into the plan or going out as an expense for the 5500 series. I have always gotten the plan auditor to sign off on this. I don’t recall a plan I worked with that did this being audited by the IRS or DOL. I will add all the plans that this happened to them it was because the trust company said they could not bill the client directly. Their system required the plan to be billed was the claim. I suspect the trust company just wanted their money faster so they took it from the plan. The trust company did not show the reimbursements as contributions either. It was just a “misc in” amount that equaled the fee amount.

There is no good answer to this question. I have had ERISA attorneys advise my clients that 1% is the max, and another 7%. 5% strikes me as pushing it, to put it kindly. I had a client years ago that used commissions and they had a version of your problem. When the economy was good enough of the salesmen were HCEs to make the test pass. The economy would slow down and they would all become NHCEs and they would fail the test. Your client might be setting themselves up for a bigger headache then they realize.

This is an interesting question. There was a recent court case where an ESOP administrator knew the company was in negotiations to sell the company for 6x last appraisal and he started pushing the terminated people to take their distribution. The administrator knew the sale was more likely to happen then not happen. The court took a dim view of this behavior to say the least.

Sorry story time: The one time I had a client in this situation this is how it played out. A bank teller was caught stealing. She pleads guilty to stealing hundreds of thousands dollars. The bank’s attorney got the local DA and judge to go along with this plan. The judge told the defendant she would get sentence A if she deposited her ESOP distribution into an account with the bank. Then she had to sign the bank account over to the bank. She would get sentence B is she did not reimburse the bank. I suppose it is obvious but sentence B was much harsher then A. Strictly speaking she made a free will choice about her benefits. It sounds like your client might want to look into something like that as a solution.

Austin you beat me to the question you asked. I would be curious also which regs people think the IRS is upholding? Like I said when I did this years ago, maybe around 10 years ago, both client’s ERISA attorney blessed the plan. If I understand this conversation the IRS is not enforcing the regs, but a contingent hypothetical. Well, IF the plan were to stick around, and IF the person where to come back to work…..

For what it is worth one of the greatest gifts a grand parent can give a kid, in my opinion, is a gift to fund a roth at those ages. My 15 year old just got his first job. I am hoping between my dad and I we can fund a roth for him for 100% of his earnings. Imagine 50 years of compound earnings tax free. That assumes that my son doesn't at some point take the money and run. He will have that control at 18.

In the examples I saw with my clients the forfeitures were allocated to the active employess at a special allocation right before the plan termination. What the business owner wanted to avoid was what he saw as a windfall for ex-employees who just so happen to still have money in the plan. The windfall being the increase in vesting even if they hadn't worked for years. The owner didn't have a problem of giving the full account balances to the current people. But in his mind the people who left had made their choice already. Might not be the law, but it was the way the clients saw it the two times I had the situation

David: Why would a BIS be important in this case? It has been years since I have seen this done but… Years ago I had more than one client that amended their plan from forfeit after 5 BIS to upon payment. Then the plan made a push to make payments just to do what the original question is asking about. That is to say they made the push to pay everyone out and then they signed a resolution to terminate the plan.

No employer should be allowed to get away with this and the TPA should either get him to fix it or resign. As long as the discussion seems to have gone to the TPA responsiblity I will add my two cents. I just don't see it as the TPA's job to be the plan sponsors parent. We can inform and that is it. I just don't see a duty to resign because of this. I worked on client that didn't put the money in the plan for years. It turned out the CFO was no good. Once the owner knew of the problem he put the money in with back earnings. We are TPAs not parents.

You have to study your document. It is going to tell you how to treat rehired people who forfeited in the past. The plan document is the only way to get the correct answer.

I just went through this with a client. Tom is correct. There is a correction method. In the case of the client I worked with there had been an employee education meeting before the year started. Everyone was putting in at least a 5% 401(k) contriubtion thus will get the full S.H. match. The correction appeared to be give the notice to the people who didn't get it. It was still a safe harbor plan for 2011 is our understanding.

Without more facts no one can tell for sure if it can be done or not. Also, you will find people on this board, me included, are slow to give hard answers questions from people who have a grievance against a company or service provider. We just don't look forward to being dragged into a fight. Thus, my answer is, "maybe". ESOPs do have a well known exception to the general rule that stops a company from changing its form of payment. Without all the facts one can't know if the exception applies here or not. I would suggest start by talking to the person in charge of handling the ESOP at the company and just ask your questions in a friendly way. They might be able to answer your questions to your satisfaction if you talk to them. (my edits were small grammar fixes)

This is true. FWIW, using both years of service and compensation as the basis for contribution allocations, you may wish to consider whether the higher paid employees are mostly the same people who have been around the longest, and more importantly, whether they are likely to continue to take the lion's share of the contributions for the next 10, 15, 20 years. Consider how that could affect testing, employee relations, and like that. Yeah, that formula worked so well in part because that company had a number of very long term rank and file employees. In fact that plan had a factory worker who had been there since he graduated from high school. As a percentage of compensation he was getting a larger contribution then the newly hired CFO. That was the other interesting fact. Since the family had sold out of the company and they had been the management, the new upper management had relatively short tenure with the company. So you are correct a years of service component like I described will be more dependent on demographics.

This is clearly an example of someone trying to be too clever. The problems noted above could be solved by giving the 1-3 year group a 0.5% contribution. I would guess that the additional cost would not be very large, but it solves a number of problems. Or use an allocation formula that uses years of service since you are already doing general testing to prove non-discrimination. I once worked on an ESOP that 25% of the contribution was allocated on years of service for vesting/ sum of all eligible person’s YOS for vesting. The remaining 75% was on compensation/compensation. It was truly amazing how much more it rewarded the long term employees vs a simple compensation/compensation formula.

The easiest way to think of this is to remember the goal is to get the person back to where they would have been if the extra match wasn’t ever put into the account. That is clearly the IRS goal with the correction methods. With that in mind it becomes clear why the earnings should come out with the forf. match. The only way to get a person’s account back to where it would have been if the match had never gone into the account in the first place is to adjust for earnings. To Tom’s example I have always understood it if $1,000 in match needs to come out but the earnings was a $50 loss you would only take out $950. Once again that puts the account back where it would be if the “error” had never happened in the first place. A person should neither benefit or be hurt by a mistake including too much match because of a test failure.

Maybe I do not understand the question. But why do you think you have to file an amended return at all? My understanding is a one person plan CAN file a Form 5500-EZ, but is not REQUIRED to file a Form 5500-EZ. You always have the option of filing the longer form, which it sounds like they did. I believe the correct answer is do nothing because nothing was done wrong.

The attached is from the IFILE system instructions. The vendor software we use (Pension Reporter by Datair mirrors this) you will see the first thing listed is accountant’s opinion. Later there is a financial statement. It is my opinion that “accountant’s opinion” is the better place to put the attachment of the auditor’s opinion. EFAST2_IFILE_User_Guide_1_.pdf

This is the very short version of the answer to your question. An ESOP that owns 100% of the stock of a S Corp sets up a tax free entity. The S corp does not pay taxes because it is an S Corp and the income passes to the stockholder(s). The ESOP being the sole stockholder is a non-tax paying entity in this case. People were setting up ESOPs and making the S corp election to avoid taxes and not offering broad base ownership to the company employees. These rules were intended to encourage broad base ownership of the company. Classic example a Dr. or lawyer in a sole practice was setting this up and their practice was not paying taxes. This was not the intent of the S corp ESOP rules. The link on abusive S corp ESOPs is about trying to avoid the various rules that are trying to stop those abuses. As for the link to ROBS that is the IRS’ position, but read it carefully. They never say it can’t be done. I agree with the problems outline here. The objection that new businesses go under and people will lose their retirement funds is a “nanny state” objection, not a legal one. I know plenty of people who have been laid off since 2007 who have spend all of their retirement saving supporting themselves while trying to find a job. Why shouldn’t they be able to take the risk of starting a business or franchise with this money? The “nanny state” somehow thinks they will be better off staying a wage slave, sorry that is not a valid objection.

This is a different topic. Your link relates to S corp ESOPs which is not the same as this topic.

You need the final audit report, sorry. I have 3 due next Wed and I don’t have the final reports yet either. Oh, the attachment is more likely called the Auditor’s Opinion.

I struggle with this as I started this thread, but... I think you can get out of the VFCP for such a small amount. See PTE 2002-51. The DOL has a de minimis amount, but not the IRS. So I think 15% of $.35 is due the IRS, or $.05 in tax is due. I know I am glad the deficit will be reduced by the huge amount. Oh wait it will cost more to process then sent in...

The ERISA book by Sal says the IRS admits they can be done. There are difficulties, and any research will show the IRS doesn't like them. But then again the IRS doesn't like S corp ESOPs and there is nothing they can do about it. The law is clear on both of these topics, difficulties-- but it can be done.

$64.25 ought to be enough to buy an actual lock box. They they can store all those gov't bonds in a nice safe place.