S-Corp and ESOP

[Belgarath]

I don't have all details yet, so I'm just asking a question in general, since I know practically nothing about ESOPs.

We have a PS plan, sponsored by an S-corp that has been around for many years. They just sent us data to do the 12-31-06 valuation, and informed us that they "established an ESOP as of 1-1-2006." Based upon verbal communication to one of our analysts, which may not be accurate, they assert that they made no contributions to the ESOP in or for 2006, yet the ESOP owns 100% of the S-corporation. We're attempting to get some clarification.

In the meantime, I have two questions.

1. Is the above situation even possible? I mean, how can 100% of the ownership be transferred to the ESOP without this being considered a contribution?

2. I know there has been a lot of press about "abusive" ESOP/S-Corp situations, which I honestly haven't folowed much becasue we don't administer ESOPs. In general, I understand that this deals with not allowing an allocation to "disqualified persons" during a "nonallocation year" and that this becomes effective in, I think, 2005. Although the ESOP isn't our responsibility, I wondered if there was a specific red flag that I should be aware of to instruct the client to double check wth their legal counsel? Presumably they have already done this, but I'm often amazed at the crazy schemes that cleints buy into because some "advisor" convinced them it was a good idea, and they didn't seek competent counsel before digging their grave.

Thanks for any input!

[QDROphile]

Your concerns about how the ESOP acquired the stock are well placed, but it could have been done by a loan to the ESOP, with the proceeds used to buy the stock. The loan gets paid out of future dividends or contributions. Perhaps the loan was at the end of the year and no payments are yet due, so no contributions have been made to cover the loan payments.

[stephen]

#2 Yes. IRC 409(p) needs to be reviewed as if the plan fails this lovely "pension simplification" the penalties are draconian!

[Belgarath]

Many thanks!

[BeckyMiller]

Belgarath - ESOP administration is a very complex world. ESOPs of S corporations are among the most complex. Leveraged ESOPs of S corporations may be the most complex. You shouldn't enter into this blind. Even if they have excellent legal counsel, they are not likely to be up to date on the day to day administrative aspects, basis tracking, 409(p) testing, diversification ilk for this situation. For example, if the profit sharing plan has been in existence for 10 years or more, there is no delay on the imposition of the ESOP diversification rules.

So - you may want to resign or subcontract with one of the ESOP administration firms to help you out. Your client can find some information about various firms that do focus on ESOP administration through the ESOP Association of America or the National Center for Employee Ownership.

[John Feldt ERPA CPC QPA]

Much like Becky described, from a business standpoint, several years ago our firm decided that doing full in-house start-to-finish ESOP work was not our specialty and thus not profitable for us. The 20 ESOPs we had were not enough to build a strong specialty admin group with. However, these clients had 401(k) plans, so we took the approach that we will be able to make enough money by doing the admin work on the 401(k). We now coordinate the results/reports with the ESOP plan, but we outsource the ESOP document and the ESOP administration to firms that specialize in ESOPs. Our involvement with the ESOP is to keep things coordinated with the 401(k) (and/or DB plan) and we are the main contact for the client.

[Belgarath]

Thank you both. Becky, fear not, we have no intention of getting involved in any ESOP administration! They have another firm handling that. I suspect the other firm will end up taking over the admin on the current plan as well, or that we'll end up dropping them if they don't get us good data in a timely fashion. Which, given past history, is pretty likely...