EBECatty

Hoping someone can provide me a quick sanity check. Plan uses regular NRA definition of later of age 65 or fifth anniversary of plan participation. Participant becomes eligible for the plan on 1/1/23, when they are age 63. They quit on 1/1/24, when they are 64, and are 20% vested. Unvested balances are forfeited after five breaks in service. They do not take a distribution. On 1/1/28, when they are age 68 and have four breaks in service, they reach their fifth anniversary of plan participation. Are they fully vested? In other words, does reaching NRA after termination restore the pending forfeitures?

I think you're looking for 29 CFR 2510.3-101, which defines "plan assets." There's a lot in that rule, but generally the corporate assets of an "operating company" are not considered plan assets so can be pledged for a bank loan to the company without causing a PT.

If you want to avoid newly hired executives entering the 401(k) their first year (then being excluded the next), you might also look at excluding from the 401(k) plan any other employee whose annualized compensation during their first year of employment is reasonably anticipated to exceed the HCE threshold for that year. I think this works as long as you pass coverage testing. You could admit them to the nonqualified plan immediately (assuming, as others note, they are part of a top-hat group).

Bumping this up with a related question. The recordkeeper/trustee of a rabbi trust is requiring a tax-exempt 457(b) plan sponsor to obtain an EIN for the trust. The plan sponsor is a federal credit union, so is tax-exempt and does not file a federal income tax return, not even a 990. Has anyone run into problems with the trustee filing a 1041 reporting taxable income to a grantor that does not file a federal income tax return?

Thanks, as always, for your input and generosity with your time and expertise. Very much appreciated.

It's allowed and is very common. See Section 409(o) of the Internal Revenue Code.

Brian, thanks for your thoughts. I was coming at this from a slightly different - and possibly incorrect - angle. The insurance carrier will allow active coverage to continue for six months. My line of thinking was whether the employer could stop making its $400/month contribution during the unpaid, non-protected leave. The employee would still be on active coverage, but would be paying the full self-only cost. If dropping the $400/month employer credit during a non-protected leave would make the lowest-cost self-only coverage unaffordable, I think it would be a problem. The follow-up would be if the employer continued the $400/month credit during non-protected leave, but only for people on the lowest-cost plan, could it drop the $400/month credit for someone on the higher-cost plan? Or, put another way, can an employer stop paying an employer credit during an unpaid non-protected leave as long as in doing so there is at least one affordable option at all times (but if the employee is not enrolled in that option, their premium will go up by $400/month)?

I'm hoping someone can help set me straight here. An employer offers two medical plans. Plan 1's self-only coverage is $500/month. Plan 2's self-only coverage is $1,200/month. In order to use the ACA FPL safe harbor, the employer offers a $400/month employer contribution toward either Plan 1 or Plan 2. After the employer contribution, Plan 1's coverage is $100/month and Plan 2's is $800/month. Assume that neither $500/month for Plan 1 nor $800 or $1,200/month for Plan 2 meets any ACA safe harbor (i.e., without the employer contribution, no coverage is affordable). The employer's policy is to stop the $400/month employer contribution if an employee is out on unpaid non-protected leave (e.g., not yet FMLA eligible, not ADA, no state law, etc.). The medical insurance policy allows active coverage to continue for up to six months. An employee is going out on a three-month non-protected leave during a stability period in which they are full-time. Active coverage will be offered for the full three months. If the employee is on Plan 1 and the employer stops the $400/month credit, the employee will not have affordable coverage ($500/month). I assume this will be a problem as the employee still needs access to affordable coverage while in a stability period. If the employee is on Plan 2 and the employer stops the $400/month credit, the employee will not have affordable coverage ($1,200/month) but is not enrolled in the "affordable" coverage (Plan 1) to begin with, i.e., it was already not affordable but they had access to an affordable plan during open enrollment. Is this a problem? What if the employer only continued the $400/month credit during non-protected leaves for employees who were already enrolled in Plan 1 (but not any other plan)? If the employer's plan terms or policies say as much, is it permissible to continue/stop the employer credit only for employees enrolled in certain plans? If so, might the cost increase allow them to switch from Plan 2 to Plan 1? Appreciate any input.

Can't point to anything specifically addressing that issue off-hand (others might be able to) but the 409(e) pass-through voting requirements generally are based on the relevant state's corporate law governing shareholder approval of corporate transactions (i.e., if the controlling state's corporate law requires a shareholder vote, the 409(e) rules generally would require a pass-through vote). I wouldn't think a buyer's federal tax election would impact the voting requirements of the underlying state corporate law, which generally would follow the form of the actual transaction.

Agree that an operating business (employing ESOP participants) that's taxed as a partnership and owned (in part) by an S corp (in turned owned by an ESOP) would be a problem under 409(l). If you already have a 100% S corp ESOP, how would an F reorg get you a lower-tier partnership with other owners? Typically, the F reorg is (1) shareholders of S corp 1 form new S corp 2; (2) shareholders of S corp 1 contribute 100% of S corp 1 stock to S corp 2, in exchange for pro rata stock ownership in S corp 2; (3) S corp 1, now a wholly owned sub of S corp 2, becomes a Q sub then converts to an LLC; (4) S corp 2 then sells 100% of equity of LLC (formerly S corp 1). Whether you have one original S corp shareholder or multiple shareholders, the resulting LLC is wholly owned by the newly formed S corp 2, no? If S corp 2 owns 100% of an LLC (that has not elected to be taxed as a corporation), wouldn't it be a DRE by default? Unless you introduce new owners to the LLC after the reorg. Hope I'm not missing something.

Wouldn't the LLC be a disregarded entity (wholly owned by the S corp) and not a partnership? If a DRE, no problem.

No, but from the ESOP's perspective it converts the transaction from a stock sale (the ESOP trust as the S corp's shareholder selling the S corp stock to a buyer) to an asset sale (the S corp selling its assets, the LLC interests, to the buyer). To the buyer, and for purposes of the deal documents, it's still a stock sale of the operating business, so this shift can be easily overlooked. The rub is that a stock sale generally does not require a pass-through ESOP participant vote, whereas a sale of substantially all assets generally does. This changes the entire dynamic of the deal, so is difficult to decide to do/change at the last minute (i.e., when buyer's accounting firm discovers some miniscule S corp infraction from 20 years ago and panics...).

My vote is answer A. The subsequent election cannot take effect for 12 months. The employee separates less than 12 months after the election change. The terms in effect on the date of separation (the payment event) control, and they call for payment one year following separation from service. Interestingly, the Section 409A Handbook lists this scenario as an uncertainty, suggesting an interpretation that the one-year delay in payment following separation from service under the original schedule might allow the employee to make a subsequent election up until the day before separation from service. It gives the example of a lump sum payment on the 10th anniversary of the employee's separation from service, and reasons that forcing an election change 12 months prior to separation from service is, in reality, an election-change deadline of 11 years before payment, which is far longer than the regulations' regular 12-month deadline. I get the logic, but I'm not sure I'd be comfortable with that approach. Would like to hear others' thoughts as well.

Would appreciate if anyone has recent experience here they can share. Plan sponsor filed its 2021 Form 5500 late. They did not use DFVCP. IRS (but not DOL) sent a notice of proposed penalty. By phone, IRS tells me that, if we re-file the 2021 5500 now using DFVCP, IRS will waive the proposed penalty. I understand that the IRS's proposed penalty notice does not disqualify the plan from using DFVCP. From IRS's perspective, this is all fine. My understanding from DOL, however, is that plans are ineligible from using DFVCP once they have already filed a 5500. In other words, once a 5500 is filed, it's no longer "delinquent" so cannot use DFVCP. I've been told by DOL in that situation that an amended return can be filed, but it cannot be filed using DFVCP. (This has been a few years now so may be stale info.) No information would be changing on the new filing; its sole purpose would be to use DFVCP. Does anyone know whether DOL will accept a DFVCP filing in that situation?

Peter, all good points. I'm thinking more generally based on the revised statutory language, particularly the interpretation discussed here: FLASHPOINT: Nerding Out on SECURE 2.0: Long-Term Part-Time, and 403(b) Plans – Ferenczy Benefits Law Center - We are your ERISA solution (ferenczylaw.com) I don't believe we've been given a clear answer from the IRS, so I'm curious what others are thinking and/or recommending at this point (and, of course, not seeking a legal opinion specific to this sponsor). The sponsor here will be affected by this rule starting in 2025; excludes student employees from deferring; correctly characterizes only students as student employees and does not otherwise use the categorization as a proxy for age/service; has some students who work under 500 hours, some who work 500-1,000, and some who work over 1,000; and wants to continue excluding them from deferring to the extent permissible by law (which would affect largely the 500-1,000 hours group on this issue). This fact pattern seems to squarely face this question and how to interpret.

This also appears to be an issue with the student-employee exclusion. Aside from the fact that this exclusion appears in the same sentence as the 20-hour exclusion, subjecting student employees to the LTPT rules seems less logical to me, particularly as the student-employee exclusion is less connected to hours of service than the 20-hour exclusion, and the proposed regulations allow non-hours-based categories of employees to be excluded even if they exceed the 500-hour threshold in two years. Some comments flag this issue too. I'm interested to hear what position others are taking on whether a student employee who works 500 hours (but not 1,000) in two consecutive years must be eligible to defer.

I think if the only exclusion is "HCEs" then they participate in their first year (assuming no immediate ownership). You could probably draft an additional exclusion along the lines of: "Any other employee reasonably expected to earn annualized compensation equal to or greater than the amount set forth in Code Section 414(q)(1)(B) in effect for the plan year." As long as that doesn't cause you to fail coverage testing, should be okay.

For what it's worth, I think practically speaking option 2 covers the most ground. You followed the document (and law) by allowing diversifications during the plan year based on the most recent valuation, but have built in a mechanism to ensure the participants are not harmed in the end. The deal is not close enough to know the final transaction value. If there's not a binding LOI, one more month will not produce a final deal value either. At this point in the year, you'll be lucky to close by year-end, which means you'll need to decide if you want to skip payouts altogether for the entire 2024 plan year. As I'm sure you've seen, deals fall apart well past the signed LOI stage, so in my mind trying to approximate the deal value a month from now and pay it to diversifying participants is a non-starter. An interim valuation would not help, in my view, unless it also accounted for the pending sale, likelihood of closing, etc. Option 1 presumably would require an explanation to participants, as ESOP Guy notes. I'm not sure what added benefit would be achieved by not diversifying at all. Plus, it seems to me that it would pretty clearly violate the plan document and statutory diversification requirements. In almost all cases with a strategic buyer, the deal value will be higher than the most recent valuation (if it's not, that's a separate fiduciary concern), so in reality you're likely only to be increasing prior payments.

Agree with both comments above. In many cases, we recommend that ESOPs still make a timely distribution/diversification payment as elected by the participant, but provide true-up payments after the transaction closes for the difference between the per-share distribution/diversification value and the per-share transaction value. There are a few ways to do this, each with its own complications. You'd need to decide where to draw the line on who gets a true-up payment; often, we will start with those who received plan distributions/diversifications after a binding LOI has been entered. But this is a judgment call in each case.

As a general rule, 409A does not govern the medium of payment (i.e., cash vs. in-kind). See 1.409A-2(a)(1) and Section III.D.6 of the preamble to the 2007 final regs. That assumes, I think, that the amount of property transferred is of equivalent value, fully vested, etc. In other words, there may be other issues involved.

Thanks. That was my initial concern as well, particularly with the 500-hour year of eligibility service definition, although it seems odd to me that an employee would be able to continually defer through consecutive breaks-in-service. Maybe it's not.

I'm hoping someone can help me here: 401(k) plan excludes employees regularly scheduled for under 500 hours per year, with a failsafe that if such a person actually exceeds 500 hours in an eligibility computation period, they become eligible. This was done to avoid LTPT eligibility tracking, i.e., anyone with one year of 500 hours will be eligible to defer, so will not become an LTPT employee. Plan also provides that 500 hours in an eligibility computation period is an eligibility year of service. BIS is 500 hours. If someone moves from an eligible to ineligible class, they may no longer defer as of the date of the move. An employee has worked full-time for several years, and will have well over 1,000 hours in 2024. As of 1/1/25, they will move to part-time, scheduled for under 500 hours per year. Assume they actually work under 500 hours in 2025. Is it permissible to move this person to ineligible status starting in 1/1/25 (the date they are no longer in an eligible class) such that they are no longer eligible to defer, despite having satisfied a year of eligibility service? If not, what about 1/1/26 after they have a one-year BIS in 2025?

It doesn't answer your question, but if Main LLC can elect to be taxed as a C corp, you might be able to avoid an ASG.

Usually one of three ways: 1. Maintain both plans separately 2. Merge the plans 3. Go back in time

For what it's worth, we have followed this structure many times with ESOP-owned companies--including receiving initial and termination determination letters--without any resistance from the IRS. In those cases, the parent company sponsors the ESOP and is a holding company with no employees. The parent company stock is used as the ESOP's employer securities. The operating business and all employees are housed in a wholly owned subsidiary (or subsidiaries). The operating subsidiary joins the holding company's ESOP as a participating employer. Edit: Just re-read the original post, which mentions not wanting to execute a participation agreement. Sorry.