409(p) failure

[Guest mickiemurphy]

I have an S-Corp ESOP that has plummeted into failure with the 409(p) testing calculations. The plan with four Disqualified Persons who have in excess of 10% ownership within the plan. The primary owner's wife also participates in the plan which combined gives them about a 19% ownership. In addition the primary owner holds outside of the plan 49% of the outstanding shares.

With the final regs, I know that I cannot target an individual to sell his shares to the remaining participants, however, I have discussed with other practitioners shuffling shares within the entire account. This ESOP has a good amount of Other Investment funds available which would allow sale/purchase prorata. Can I sell prorata then prohibit the Disqualified Persons from participating in the repurchase?

I can't fix the 49% outside of the plan, but any suggestions or other correction techniques would be greatly appreciated.

Thanks.

[BeckyMiller]

Have they already failed 409(p) or are you just projecting that they will fail? This test has that nasty requirement to be satisfied on each day of the plan year. Under the final regulations, it is very difficult to correct an existing failure unless the plan already includes some correction language. I know it seems like we say this way too frequently in this board, but you should contact legal counsel who are experienced with ESOPs of S corporations.

[Guest tmills]

I completely agree with Becky about contacting legal counsel. Once you truly fail, you are effectively dead, so hopefully you are just doing projections. I have seen plans that prohibit allocations to participants that would make them DQP's, especially if they are HCE's. Check the document to see if there is any language regarding that. Also check with the author of the document, especially if s/he is not the same person you will contact about the (projected) failure to see if they have any ideas. The document would have to allow for the sale/purchase idea you propose. Also, the final regs state that if assets in the accounts of one or more NHCEs are mandatorily exchanged, then in the absence of other relevant factors, the plan would generally be expected to fail tto satisfy the nondiscriminatory availability requirement of 1.401(a)(4)-4. Bottom line, they have already thought of what you are proposing. Good luck.

[Guest mickiemurphy]

Thanks for your input. I'm afraid the attorney who drafted the plan is asking me for fail-safe language, which doesn't make me very comfortable. Looks like I may have a train wreck on my hands!

[BeckyMiller]

You might suggest that your client or their legal counsel contact the ESOP Association, ESCA or the NCEO for names of attorneys who are focusing on this issue. I have heard a lot of conversation at cocktail parties where certain advisors think that these regulations are so severe that they need to be challenged in Court to see if they go beyond the intent of Congress. Now - I can't say that your client may have much hope - Congress did give the Secretary a fair amount of authority in this regard and there were cocktail parties, so it may have just been the liquor talking.... But, if big amounts are involved, your client may wish to pursue this further.