Zero Interest Loans

[Kirk Maldonado]

Is there any reason why an employer could not make a zero interest loan to its ESOP?

I want to emphasize that I'm only asking whether there is any prohibition on no interest loans; not whether it is a prudent decision .

[RLL]

Hi Kirk ---

It's not prohibited under ERISA or the IRC, but it raises sticky tax issues....IRC section 7872, as well as sections 404(a) & 415© if it's an S corp or if the "1/3 test" isn't satisfied. In addition, it may raise shareholder issues if the ESOP is not the 100% shareholder or if non-ESOP shareholders don't consent. There may also be accounting issues....but I don't understand accounting well enough to know much about this. Also, could there be creditor issues?

I thought you weren't doing ESOP work anymore.....

[Kirk Maldonado]

RLL:

I noted that the prior exception from 7872 for ESOPs has been repealed. Although I'm not an expert on that section, my understanding is that it results in imputed income for low (or no) interest loans. However, because the ESOP is exempt from income tax anyway, the need for the exemption from 7872 wasn't immediately obvious to me.

As to Sections 404 and 415, you raise good points, but I keep coming back to the point that the amount of the interest paid is, to some extent, meaningless because the amount of interest paid to the employer is simply the employer repaying itself. Thus, I could see the IRS challenging a high rate of interest paid because it artificially generates large deductions (and violates the regs), but it would have little incentive to challenge a low rate of interest (because imputing an interest rate would generate larger deductions for the employer).

Similarly, I'm not too worried about creditor issues, because creditors are not disadvantaged by the absence of interest (other than the employer losing a possible deduction).

I would look at the shareholder issue in the same vein.

As to the accounting issues, although I am deeply embroiled in the accounting issues relating to stock options, like you, I haven't mastered the accounting treatment of ESOPs. Part of that is because, to a large extent, accounting rules relating to employee benefits for privately held employers are irrelevant. Also, I feel comfortable punting on accounting rules because the auditors will have the final say anyway.

The original plan was that I was to do exclusively stock compensation at my new job. However, with (1) the slowdown of the economy, (2) the dearth of ERISA attorneys at my new firm, and (3) some of my old clients asking me to continue to represent them, I'm continuing to do some ERISA (including ESOP) work.

[RLL]

Kirk ---

The fact that an ESOP is tax-exempt does not eliminate possible problems with imputed interest in connection with a no-interest ESOP loan. To the extent that interest were to be imputed, there could be imputed employer contributions which might result in exceeding the IRC section 404(a) and 415© limits. Why take this risk?

It's too bad that you're again stuck with doing ERISA work. I thought that you had negotiated your release.

[Kirk Maldonado]

RLL:

Do you know why they deleted the exclusion for ESOPs from Section 7872?

The portion of my practice that is ERISA based has gone down from approximately 60% to about 10% to 20%. That is a big improvement, although not complete relief.

Maybe some day I'll be able to become a retired ESOP attorney.

[RLL]

Kirk ---

IRC section 7872 included an exemption for below-market-rate ESOP loans made in connection with the section 133 lender's interest exclusion. When section 133 was repealed, the corresponding 7872 exemption was repealed.

The ESOP exemption in section 7872 was intended to allow for below-market-rate loans between employers and ESOPs ONLY in connection with "back-to-back" loan transactions contemplated by section 133. It was not intended to provide an escape from the possible consequences of imputed interest and imputed contributions on all ESOP loans.

20% ERISA work is enough to make one want to give it all up. Try to keep yourself closer to the 10% level.

Is there a difference between a "retired" ESOP lawyer and an "unemployed" ESOP lawyer? When a lawyer who deals with retirement plans becomes unemployed, does he/she call it retirement?

[IRC401]

If the interest rate is zero, are shares releases from the suspense account using the principal only method or the interest plus principal method?

I haven't thought it through, but if you were dealing with an S Corp, could the choice of the interest rate affect whether the new excise tax under 4979A applies?

[RLL]

Hi IRC401 ---

I think I remember algebra sufficiently to conclude that: if I = 0, then P + I = P.

Your question does raise a good point. It would appear that an interest rate of "zero" might result in a requirement (under the ESOP loan regulations) that the loan be amortized in a manner that would qualify for share release on a "principal only" basis. Another reason to avoid having a no-interest rate ESOP loan.

I don't understand your question regarding the new excise tax under section 4979A....maybe it's because I'm not good at new stuff.