MBESQ

The same broad statutory exception to the anti-cutback rule is also found in ERISA. Based on the premise that the corresponding Treasury regulations attempt to narrow the broad scope of the statute, it seems unlikely that a court would find unacceptable an action that was acceptable to the IRS in this context. The larger risk would be to change distribution options beyond the scope of the regulations relying on the statutory language alone. Also, the plan amendment language might not allow the contemplated change if it prohibits plan amendments restricting distribution options without mentioning the broad statutory ESOP exception. All qualified retirement plans are supposed to contain language prohibiting such plan amendments, and this is an instance where careful drafting of ESOP plan documents is productive. Again, best to confer with legal counsel.

Generally, there is a broad exception for ESOPs allowing changes to distribution rules without violating the anti cutback rule in the statute on protected benefits. The regulations have interpreted this exception more narrowly. So best to consult with legal counsel on the proposed change and the scope of the amendment to the plan and/or distribution policy.

There is a good chance that the new proposed regulations will be withdrawn or never published officially. Unfortunately, the new preamble is a summation of many things that the DOL finds troubling with ESOP transactions, and it’s not that ESOPs are bad per se. In many respects, the rationale behind certain aspects of the 1988 proposed regulations have been undermined by the extensive discussions in the new preamble. Of course, none of these documents are legally binding in court. However, the new preamble does not paint a pretty picture other than from the perspective of a plaintiff’s attorney looking for a road map.

It’s not clear in your second paragraph how two participants can have a “negative contribution amount.” If this is due to Section 415 limits, the IRS has specific correction procedures. You should consult with your attorney on this. If the negative amounts are due to the decrease in stock price due to the releveraging, generally keep in mind that ESOP loan allocations due to employer contributions derived loan payments involve share accounting. When dividends or S corp distributions attributed to allocated shares are used for loan payments, the fair market value rule requires that participants receive an allocation of shares with a fair market value (FMV) at least equal to the cash that would have otherwise been allocated to their accounts. If the FMV allocation rule cannot be met, then there are compliance issues in using these funds for loan payments. I would caution against using released shares from employer contributions to comply with the FMV rule, because the allocation method from this contribution source may deviate from the safe harbor non discrimination allocation method (such as a uniform percentage of compensation) and perhaps even the terms of the plan. The FMW rule for using allocated dividends and distributions for loan payments does not override other plan qualification rules. You need to follow the terms of the plan document in making allocations. One possible approach involves using distributions on unallocated shares to comply with the FMV rule, but it appears that a plan amendment would be required.

If these payments are not dividends under the Internal Revenue Code, then they’re not covered by Section 404(k), which governs deduction of dividends for shares owned by an ESOP sponsored by a C corp. Accordingly, the payments would not be deductible if they’re not dividends. In this case, another issue is whether they should have been paid to the ESOP, which is the shareholder (not the participants) and, correspondingly, was there an impermissible in-service distribution not authorized under the terms of the ESOP plan? The pass through payment for dividends plan provision likely would not apply. The plan sponsor should consult with an ERISA-ESOP attorney about a correction process.

There are deduction, plan qualification and prohibited transaction issues involving failure to adhere to the make-whole rule when dividends paid on allocated shares are used to make ESOP loan payments. It’s pretty complex, and echoing ESOP guy, you need an experienced ESOP attorney to address these.

The reasons for the differences in value are beyond the scope of the facts presented. However, a higher redemption price for other shareholders could be dilutive to ESOP share value. This could raise fiduciary issues under both state corporate law and ERISA.

To meet the definition of an “established securities market,” the OTC Markets Group must be a national securities exchange that is registered under Section 6 of the Securities Act of 1934, as amended. The OTC Markets Group is not found on the SEC’s list of national securities exchanges. https://www.sec.gov/rules/sro. On another web page, the SEC indicates that the OTC is not a national securities exchange. https://www.investor.gov/introduction-investing/investing-basics/glossary/over-counter-otc-securities Note that the definition is based on the status of the trading market. Whether the issuer of the securities sold the securities in a public offering registered under the Securities Act of 1933, as amended, or is a reporting company under the 1934 Act is not determinative. The definition, therefore, treats plans with OTC securities similarly to plans sponsored by private companies in many respects.

The facts seem incomplete, but a few thoughts based on the original post: 1. Confirm the share release method used. If the plan was using the principal only method, there could be a problem with a balloon payment. Often the release method is stated in the ESOP loan documents. 2. If the principal and interest method was used, but no employer contribution or loan payments were made, there would not be any shares released for allocation. An agent might be inclined to think that the loan was not for the primary benefit of the participants (a requirement for such a loan and typically required by the IRS to be stated in the plan document). The $20K acquisition price might be a factor in the government’s unwillingness to allow catch-up payments if the price was substantially below fair market value. The agent may view the ESOP as being put in place to avoid corporate taxes and not to provide an employee retirement benefit and promote employee ownership. The context may matter here.

The LLP could convert to a C corporation and do an ESOP, but it may not be an efficient tax approach for the owners and often Sec. 1042 will not be available. Generally Sec. 1042 requires a 3 year holding period, and the LLP holding period will not be included if the incorporation is not tax free to the owners. See Sec. 351 and Sec. 368(c) for the control requirement following incorporation and case law and rulings on the step transaction doctrine applied by the IRS. If Sec. 351 does not apply, the incorporation is treated as a termination of the partnership and the related tax consequences to the partners needs to be analyzed.

My initial impression is that the tax would not apply since the exec is employed by the company owned by the ESOP and not the ESOP itself, which is the Sec 501(a) tax-exempt entity under Sec 4960. The company may not be taxed on corporate income if it is an S Corp., but that does not make it a tax-exempt entity for purposes of Sec 4960.