Establishing an ESOP

[Guest SCUDDESLER]

Section 404(a)(6) of the Internal Revenue Code of 1986 (the “Code”) permits an employer to deduct contributions retroactive made to a qualified retirement plan. However, in order to take advantage of Code 404(a)(6), the plan to which the contributions are made must be in existence no later than the last day of the tax year for which the deduction is claimed. Consequently, while contributions may be retroactive made to a previously established plan, a plan cannot be retroactively established. The question presented is this: when is an ESOP “established” for purposes of the retroactive contribution rule described above. For example, if an employer has a tax year ending 9/30/2002 and would like to make and deduct a contribution for that tax year to the ESOP, is it enough if the plan document is signed by 9/30/2002 even though the stock sale/purchase transaction will not occur until later so long as the stock sale/purchase transaction occurs before the employer's income tax return is due and the other conditions contained in Code § 404(a)(6) are satisfied? Or, must the stock sale/purchase transaction be completed by 9/30/2002 as well? Must any documentation other than the plan document itself be signed by 9/30/2002?

Thank you very much in advance for your comments.

[RLL]

Hi SCUDDESLER ---

The ESOP plan document must be duly adopted by the company (usually requiring formal action by the board of directors) not later than the last day of the company's taxable year. In addition, a valid ESOP trust agreement (which may be included as part of the ESOP plan document or may be a separate document) must be duly adopted by the company and executed by both the company and the initial ESOP trustee(s) not later than the last day of the taxable year.

Just as with the adoption of any other type of qualified employee plan under IRC section 401(a), there is no requirement that the ESOP trust be funded by year-end so long as contributions for that taxable year are paid to the trust by the due date (including any extension) for filing the company's federal income tax return, per IRC section 404(a)(6). The ESOP's initial acquisition of stock may be made at any time, either before or after the close of the taxable year and either before or after the due date for making contributions.

Note, however, that in order for ESOP contributions (which are used by the ESOP for loan payments) to be deductible under the special provisions of IRC section 404(a)(9), the ESOP loan should be in effect by the close of the taxable year....and any interest accruing on the loan after the close of the taxable year would likely not be deductible for that year.