loan payments and stock allocations after year end in a new ESOP

[Guest tmills]

Here is the situation. New ESOP effective 1/1/04. Sale of shares to plan, loan agreement, etc. not done until 4/29/05. First loan payment due 12/1/05, prepayment allowed. Employer wants to make a payment/contribution now up to the 404 limit for the 12/31/04 PYE and show on the 12/31/04 statements shares released as a result of this "loan payment."

Plan allocates any cash contribution to an other investment account and permits it to be used for loan payments if employer contributions are insufficient to make the payment. Otherwise the trustee has discretion over how assets are used, but the account is primarily to buy stock directly from any available source. The employer would prefer not to show the cash on the '04 statement and the share release on the '05 statement because the value of shares received will be less than the cash w/drawn.

Financial advisor says no problem w/ showing an accrued loan payment and allocating shares as of 12/31/04 as long as the loan transaction was completed w/in a reasonable time after the end of the year because at 12/31/04 everyone knew that the leveraged transaction was coming soon.

I'm having a bigger problem w/ the participant statement side of this than the loan payment part, although I don't really like either one. It seems to me that the participants are being misled by giving them '04 statements w/ shares. In addition, showing the transaction this way allows the trustee to escape scrutiny. However, I can't point to anything specific that would prohibit accounting in this manner. As far as the loan goes, they are using an '04 contribution to make payments on a loan that didn't exist then. With the first payment due 12/1/05, they can't claim employer contributions were insufficient as of 12/31/04. I would appreciate any thoughts on any part of this transaction.

[Guest DMZ]

Well, I will take a stab at this one since no one else has responded. Maybe we will get some discussion going. In general I do think you can release shares from suspense based on an accrued loan payment, BUT I am not comfortable with this set of facts since what you are accruing here is not just the release of shares, but there would be an accrual by the plan for obtaining the shares and the loan itself. As of 12/31/04 as you mentioned, the plan does not even own the shares. How can they release shares that the plan does not even own?

The basis for releasing shares based on an accrued loan payment that is made in other circumstances comes from IRC Reg. Section 54.4975-7(b)(8). IRC Reg. Section 54.4975-7(b)(8) provides that the numerator of the share release fraction is either the principal paid or the principal and interest paid for the plan year. Because this phrase is ambiguous, a plan administrator is allowed to make an election to interpret that to mean during the plan year (cash basis) or on account of the plan year (accrual basis). The election made does need to be consistent to avoid any issues that they have changed their accounting method on an arbitrary and capricious basis.

(i) General rule. In general, an exempt loan must provide for the release from encumbrance under this subdivision (i) of plan assets used as collateral for the loan. For each plan year during the duration of the loan, the number of securities released must equal the number of encumbered securities held immediately before release for the current plan year multiplied by a fraction. The numerator of the fraction is the amount of principal and interest paid for the year....

Since a contribution made after the end of the plan year can be attributable the prior plan year, similarly, any debt payments made after the end of the plan year with the accrued contribution can also be considered payments made for such plan year.

[BeckyMiller]

I agree with DMZ's comments. I also appreciate the client's desire to show the employees something related to ownership.

My suggestion is that you and your client put on your creative hats. Remember, ERISA does not require annual participant statements of account balance. What is required is a statement of accrued vested benefit in the event the participant requests such statement.

Thus, this voluntary reporting can be more innovative (read that not misleading). Perhaps for the first year, you just tell them a story about what has happened, how a leveraged ESOP works, etc. At the end of the story you can tell them that their contribution for 2004 was applied to the debt incurred in 2005 and they can expect to receive XX shares from that payment. Give them the estimated 2004 value of those shares. Tell them to eagerly anticipate their 2005 statement for more of the story.....

Whatever. Be creative, just stay legal and don't make any promises you can't keep. I bet more employees would read the story than would look at a statement that said Opening balance $XXX, contributions $XXX, loan payments ($XXX), shares or value at end of year $XXX.