ESOPs - Contributions of Employer Stock

[Guest Eprail]

This seems like a question for which there is an obvious answer, but I have had a difficult time finding a concrete answer under the law.

A publicly traded company sponsors an ESOP comprised of both a stock bonus plan and a money purchase plan. Under the money purchase portion of the ESOP, the employer must contribute 5% of compensation. The contributions are made in the form of employer stock, not cash. Is the number of shares contributed and allocated to participant accounts based on the market value of the shares on the allocation date under the plan document (e.g., the last day of the plan year), or is the number of shares that must be contributed based on the market value of the shares on the date the contribution is actually made?

Using the improper value could lead to potential deduction or 412 problems if there is a fluctuation in the value of the stock.

For deduction purposes, it is my understanding that the deduction would be determined by multiplying the number of shares contributed by the market value of shares on the date the contribution is actually made. Would 412 apply a similar rule? That is to say, would the number of shares needed to satisfy the minimum funding obligation also be determined based on the market value of shares on the date of actual contribution?

Thank you in advance for your input.

[RLL]

Hi Eprail ---

It is clear that the market value as of the contribution date is used for purposes of IRC sections 404(a) and 415©.....see Reg section 1.415-6(B)(4) for the rule under section 415. For these purposes, the IRS position is that differences in value between the contribution date and the allocation date are treated as appreciation or depreciation in the stock value that does not effect changes in the $ amount of the employer's contribution (but only changes the $ amount allocated to participants' accounts as of any other date).

It thus appears that IRS would apply the same rule under section 412....unless there's something in the 412 regs that says otherwise (you can do the research).

[Guest Eprail]

RLL-

Thanks for the response. I'm not disagreeing with your answer. That's clearly where we would like to come out, and, in fact, I don't think anyone I've spoken to seriously disputes the answer. Well, almost anyone.

What we're facing is a person who insists that the contribution should be based on the fair market value of the employer securities as of the last day of the plan year. Since that person just happens to be the client, we anticipate being asked to provide the basis for our conclusion. We have generated some legal support for our position - your cite to the 415 regulations included. But it's somewhat surprising that what should otherwise present, we believe, a fairly common issue (i.e., the money purchase ESOP sponsor which contributes employer securities to the ESOP post-plan year) has never been expressly addressed by the Service, the DOL or the courts - formally or informally.

[RLL]

Eprail ---

Both the IRS and the DOL treat a contribution of property (such as employer stock) which is made to satisfy a contribution obligation as the equivalent of a contribution of cash with an immediate purchase of stock at the then fair market value. Maybe you can find something more on this by researching the prohibited transaction issues relating to contributions of property.

[mbozek]

Amount of deduction is equal to FMV of property on date of contribution. See Rev. Rul 73-583. no brainer. If fvm is greater than er cost er has taxable gain. Rev Rul 73-345. But loss is not deductible. RR 61-163. Complete cites are in tax facts Q-365.

[RLL]

Hi mbozek ---

We're discussing contributions of employer stock here. A corporation does not recognize gain or loss in connection with sales or purchases of its own stock.

[mbozek]

RLL: I agree that for accounting purposes and treasury stock the no gain/no loss rule applies but I was thinking of the case where an employer buys co stock on the open market at $10 a share to contribute to the plan. As of the date of the contribution the stock has a fmv of $11. Does the er recoginize a gain of $1? Or does the er deduct $11 and pocket the $1 as a non taxable gain?

[Guest Harry O]

See IRC Section 1032.

[RLL]

mbozek ---

No......

[mbozek]

RLL: does your response mean that the employer can deduct $11 on shares purchased at $10?

[Guest Eprail]

Thanks all for your replies, but we're getting a little off track here.

mbozek, I know about Rev. Rul. 73-583, but look closely. It really doesn't answer the question. It deals with the amount of the employer's deduction. I agree that, for deduction purposes, the value of the stock on the date of contribution controls. My question is subtly different.

Suppose, as in 73-583, I have a money purchase obligation to contribute 5% of compensation at the end of the plan year (assume a calendar year plan). On December 31, my contribution liability is $1000 and my employer securities are worth $50 a share. So, if I were to contribute stock on December 31, I would be contributing 20 shares.

But suppose I don't make my contribution until March, at which time the stock has dropped to $20 a share. Do I need to contribute 50 shares (50 x $20 = $1,000) or 20 shares (i.e., as if my minimum funding obligation relates back to the end of the plan year)? If the latter, as a participant, I'm going to be upset about the loss in value that I was unable to control due to the time lag between year end and contribution.

But what if the price goes up in the interim, say, to $100 a share? Now, contribution of the original number of shares (i.e., 20) looks great to the participant (because his/her investment has doubled (i.e., 20 x $100 = $2,000), but the sponsor may have violated the minimum funding requirement.

Welcome to my world.

Again, if you look at the revenue ruling, it doesn't address the funding question. (In fact, I think it wrongly implies by its example that you base the number of shares on the stock's plan yearend price.)

Nothing I have found in 412 (or 404, for that matter) provides that the deduction amount (as per 73-583) drives the minimum funding obligation.

[RLL]

mbozek ---

If the fair market value per share is $11 on the contribution date, the employer's deduction is $11/share. It doesn't matter how much (if anything) the employer paid to purchase the shares of employer stock.

Ephrail ---

If you treat a stock contribution as a contribution of cash with a simultaneous purchase of stock (at then fair market value), it makes sense to use the value on the actual contribution date as the amount contributed for purposes of IRC section 412.

[pjkoehler]

Ephrail: Isn't the answer to your "funding question" a function of how the employer contribution credit to the Funding Standard Account prescribed in Sec. 412(B)(3)(A) operates for MPPs, i.e. "the amount considered contributed by the employer to or under the plan for the plan year?" For Sec. 412 purposes, the focus is on having a nonnegative FSA for the "plan year." Code Sec. 412©(9) mandates that the plan conduct an annual valuation of the plan's liability not less frequently than once every year, which if performed on a current year basis (as would be the case of MPP) must be as of "a date within the plan year to which the valuation refers . . . ." Since, under Sec. 412©(10)(B) an employer contribution made within (effectively) 8 1/2 months after the plan year end "shall be deemed made on such last day," it would be reasonable to conclude that the balance in the FSA should be determined using the FMV of the employer's in-kind contribution as of the last day of the plan year if it is made any time during the 8 1/2 month period. See also Sec. 412©(2)(A) and Treas. Reg. Sec. 1.412©(2)-1(a)(3).