plan termination & qualifying employer security

[lexi]

I have an employer that used qualifying employer security (a promissory note) to fund its DC plan. The ER now wants to terminate the plan and:

1) Distribute to each participant a pro rata share of the promissory note; and

2) Advise the employees to roll it over into an IRA.

Can both (or either) be done? If so, is there caselaw and/or Code/reg guidance on the issue?

Thank you in advance to anyone who may be of assistance!

[Guest mjb]

How is the note going to be allocated to the P upon plan termination ? Only way I know of is for plan to establish a taxable trust under IRC to hold promissary note for plan participants and issue certificates to each P for the amount of their interest in note. P can then rollover their cert to an IRA custodian who will accept the cert (but there will be very few takers if the note is not publicly traded on an exchange.) Trust will have to file tax returns under IRC until asset is liquidated. If not cert is not rolled over the P will be taxed on imputed income. There are PLR on setting up a wasting trust for illiquid RE of which this similar.

Q for U: How can an emplmoyer contribute a P note as a Plan asset? I though that P notes were not permissible investments under ERISA and not eligible for tax deduction.

[Kirk Maldonado]

See ERISA section 407, which allows a plan to hold qualifying employer securities, which term includes debt instruments if certain conditions are met, which are pretty stringent.

[Guest mjb]

But is there a tax deduction for contributing a P note to the Plan? If there is no tax deduction are there other collateral consequences, does plan have to authorize acceptance of such an asset?

[Locust]

I agree with the comments above. It's probably not a qualifying employer security because the 407(e) definition is stringent. It would probably be considered a loan from the plan to the company, which would be a prohibited transaction. As a prohibited transaction, it would have to be corrected - coming up with cash to pay off the note - and would be subject to excise taxes until corrected.