Annual loan payment from annual contribution

[dmwe]

In my past experience with leveraged ESOPs, the company will pass their loan payment through the trust and based on the plan document, at the end of the plan year, you calculate how many shares should be released based on a formula and allocate those shares.

I've got a new leveraged ESOP client and he is making the annual ESOP contribution today and then in January wants me to use some of that money to make his loan payment.

I've never allocated contributions in cash to eligibles and then subsequently used some of that money to make a loan payment and then, at the next year-end (8/31), released shares based on that payment.

Does that work or make sense? I'm more inclined to not allocate the amount of the contribution that equals the loan payment and hold it in suspense until January.

Any guidance?

[Guest tmills]

So you have a 9/1-8/31 plan year and the employer is making a contribution now for a payment due in January? Is the contribution being made now for the PYE 8/31/08 or 09? If 09, I don't see a problem. If the contribution is for 8/31/09, and the plan has annual allocations, the released shares are the only thing that will be allocated at 8/31/09. Also if for '09, how would you know who to allocate it to and on basis would you use allocate it now?

If the contribution is for 8/31/08, then I don't see how you couldn't allocate it b/c if you don't, it won't be deductible unless the shares released in Jan. will be related back to the 8/31/08 plan year, and that is a stretch. Your question also says you would allocate them at 8/31/09. Check the plan document to see if allocated cash can be used for loan payments. If yes, no problem.

More info please.

[dmwe]

The current cash contribution is for the 8/31/08 PYE but the loan payment isn't due until Jan. '09. They'd like me to use part of this cash contribution for the '09 payment. Shares released, related to this payment, will not happen until 8/31/09.

Timing-wise it doesn't sound right to me either. I'm not sure the document contemplates how we actually account for things as a TPA, but I'll take a look.

[Guest tmills]

If the plan document allows allocated cash amounts to be used for loan payments, which would also require the shares released by such loan payments to be allocated prorata on the cash accounts used, then I don't see a problem with what the client wants you to do.

[dmwe]

It would appear that since the client is taking a tax deduction for the entire contribution for the year ended 8/31/08 that I'll have to allocate it all as of that PYE and then, on a prorata basis, use participant cash to make the loan payment in January and then release those shares at that point.

But since we only do annual allocations I'll wait until 8/31/09 PYE to allocate those released shares - also prorata based on the cash used to make the payment.

Does that make sense?

[BeckyMiller]

That sounds right. The big issue for these arrangements is the handling of distributions. If they are deferring distributions for 1 to 5/6 years or until the debt is retired for a C corporation, your client is probably o.k. But, if they are making immediate distributions, they could have an issue. The contribution accrued goes into the participant's account. That accrual includes interest and principal that is going to be disbursed in January. But, you only do annual allocations, so if I retired during the year and get a contribution for that year which is to be paid out shortly after year-end, that amount includes funds that the employer is expecting to have to pay principal or interest. How much of an issue is a function of how many distributions they have that fall into this category - get a contribution for the year and get an immediate distribution after year-end. Typically that is a pretty small number. I just wanted to highlight the issue.