What can ESOPs do with corporate distributions?

[lexi]

I have been scouring secondary materials looking for a list (exhaustive or not) of permissible uses by an S-corp ESOP of corporate distributions.

I have found some (e.g., funding repurchase obligation, repurchasing stock distributed to an IRA, buying additional stock, paying down ESOP loan and plan expenses) but i can't find the statutory authority for these things. is there a code section or IRS materials explicitly permitting these uses of corporate distributions?

[BeckyMiller]

Well - you probably won't find much specific guidance. The right for ESOPs of S corporations to use S distributions to service debt is best described in the legislative history. I think it was either EGTRRA or the Jobs Creation Act. It references Section 404(k) and provides that S distributions on eligible allocated shares may be used for debt service if the return for value requirement of Section 404(k) is met.

Some guidance are in the ESOP regs. under Section 4975. But in general, it just comes down to what the plan document authorizes and what fiduciary conduct permits.

The BNA portfolio on ESOPs is pretty good on this stuff.

[Guest crosseyetester]

Related to 404(k), an ESOP has decided that effective 12/31/06, allocated and unallocated dividends will all be put into suspense to be used to pay down the stock. This is the first time I'm working on such a transaction and I have not been provided with instructions yet on how to release shares of stock at 12/31/06 related to the fair market value of the dividends. Assuming that this share release is then based on the 12/31/06 stock valuation, which may not be released for months, then I am unable to calculate that share release. My question is related to diversification. As it is, the diversification will be based on 12/31/05 stock value if we want to do it now, but if I cannot calculate this additional share release, can the diversification amount really be calculated?

[BeckyMiller]

I would check with counsel who drafted the document to see what was intended. It is common to see shares allocated back based upon the ratio of debt service paid with allocated dividends to total debt service. Then, if some additional amount is required later to satisfy the return for value rule, that amount can be added to the participant accounts to make sure that they received shares whose value was at least equal to the dollar value of the dividends used for debt service.

The timing of diversification is always a problem for privately held ESOPs. It seems that the appraisal process is getting faster, but rarely is all the work done in time to actually do diversification in accordance with the timing set by the statute. Do your best - get notices out based upon the best information available and let the participants know that these are estimated numbers. Then execute their direction based upon the final numbers. If there is a big difference between the estimates and the final numbers, the client should check with counsel to see if they should update the participant instructions.