Definitely Determinable Benefit (Principal Only vs. Principal + Intere

[Guest EMC]

An ESOP Plan document (leveraged ESOP) allows the ESOP Committee to choose between Principal Only and Principal + Interest for the annual allocation of financed shares. This design was chosen for maximum flexibility. Anyone see a problem with the "definitely determinable" benefit requirement? In other words, is only one of these methods, to the exclusion of the other, allowed in the plan document?

Thanks in advance for any feedback.

[pjkoehler]

EMC: Interesting question. A profit sharing plan is required to provide a "definite predetermined formula for allocating the contributions to the plan among participants and for distributing funds accumulated under the plan . . . ." Treas. Reg. 1.401-1(B)(1)(ii). Regs that govern the exempt statuts of an ESOP loan provide that the ESOP "must consistently allocate to the participants' accounts nonmonetary units representing the participants' interest in the assets withdrawn from the suspense account. " Treas. Reg. Sec. 54.4975-11(d). These regs explicitly incorporate the general qualification rule as part of the exemption requirements.

Furthermore, while the release from encumbrance rules provide for the use a release fraction based on principal only as a special rule, it refers a procedure in which the shares released are "determined solely with reference to principal payments." See Treas. Reg. Sec. 54.4975-7(B)(8)(ii). This language in the reg could be read to require a loan document to specify a single release formula for all releases, which, of course, precludes employer discretion. On the other hand, it could be argued that "solely" just limits the factors considered in the formula.

So what's at stake here is not just the qualified status of the plan, but whether or not the loan is an exempt transaction.

[Kirk Maldonado]

It seems that if the release fraction changes were manipulated so as to maximize the allocations to the highly compensated employees, you could have a problem.

[Guest EMC]

Even if you only have 1 of these 2 allocation formulas in your document, if you discriminate in favor of HCE's, you've got a problem -- that's a given. The question, however, is whether the mere flexibility provided by the document to allow the ESOP committee to choose between "principal + interest" or "principal only" for a given year violates the definitely determinable benefit requirement.

From a practical standpoint, an ESOP document could be drafted with one of the other method spelled out and then be formally amended each year if there was a desired change to the allocation formula change. This particular document was drafted so the burdensome formality of formally amending the plan was removed and the choice is built into the document.