Rollover of proceeds of mandatory put

[Guest tmills]

Here is the situation. S Corporation esop distributes shares and cash balances to terminated participants the year after termination. Shares must be put to the corporation and are immediately redeemed. The participant of course never actually sees the shares. If a participant elects a rollover, the entire balance of plan cash and cash from the stock sale is rolled. (Not clear yet if that is via a esop trust check and a corporate check or one corporate check.) The 1099R from the plan indicates a rollover of the cash amount. No NUA indicated. Are there any problems with rollovers being accomplished this way?

Rev. Proc. 2004-14 goes into detail about allowing the esop trust to roll shares to an IRA as long as they are immediately sold back. If so, the S election is not blown. However in the above scenario shares are not rolled so I don't think that applies. However, the answer to the above question may be that shares should be rolled and the IRA trustee be the one who exercises the immediate put. In which case 2004-14 would apply, but only to affirm that the S election is safe.

My feeling is that the employer's method above gets the participant and employer where they want to be at the end of the day. However, I'd like to be convinced that it is truly okay. Obviously there is no real problem with the rollover of the cash portion of the participant's esop account. However, the participant does for a split second "receive" the shares from the esop, then puts them to the company, "receives" cash from the sale, and rolls the cash. So is it correct for the plan to report a single cash rollover. Or should it report both the cash rollover and the share distribution. If the share distribution is reported, then NUA is invoked and when the participant sells, he could have capital gain issues, unless he rolls the proceeds (which may still be considered a distribution from a plan?) within 60 days of "receipt" of the stock. Of course there is the side issue of whether paying capital gains now and not rolling is smarter than rolling and paying regular income tax when distributed from the IRA. But I won't go there.

I've searched the forum for this issue and there is a post by Janie 6/2/03 that is very similar to my question. QDROphile noted that it is possible that cash will be delivered to the IRA as a courtesy so it looks like a direct rollover, but didn't indicate if that was okay under the code. Sorry for going on so long. I'd appreciate any help as the company will be doing 2008 distributions soon and also wants to know if there are issues with prior distributions that should be corrected.

[QDROphile]

You don't have a direct rollover if the formalities do not involve a first step of transfer of ownership of the distributed asset from the trust to the IRA or other eligible retirement plan. Skimp in the formalities at your peril.

[RLL]

The ESOP is distributing both cash, which is directly rolled over to the IRA, and shares. The distribution of shares (exempt from withholding) is followed by an immediate corporate redemption. The cash proceeds of the redemption (a sale of the shares) are then rolled over to the IRA.

The share portion of the distribution (and rollover of the redemption proceeds) does not constitute a direct rollover. It's a rollover of the cash proceeds resulting from the sale of property distributed from the ESOP, per IRC section 402©(6).

Seems to me to be OK.

[Guest mjb]

Why isnt this the distribution of property eligible for a rollover followed by an immedate sale? IRC 402©(6) permits a rollover of the proceeds from the sale of property received in a distribution as the transfer of property received in the distribution. Are stock certificates issued in the name of the participant and then put back to the company?

[RLL]

The shares are distributed from the ESOP to the distributee and then immediately repurchased by the company. This is not a "put back to the company" .....it's an automatic "call" (redemption) of the shares by the company.

If the paperwork is done properly, there is no requirement to issue a stock certificate in the name of the distributee. The ESOP would deliver the distributed shares to the company (or its transfer agent). The shares would then either be held as treasury shares or would revert to the status of authorized but unissued shares (depending on applicable corporate law).

[GMK]

I am intrigued by RLL's approach, but we will continue to first transfer the distributed assets (shares or cash) from the ESOP trust to the rollover IRA or qualified plan, as QDROphile describes in post #2. Stock certificates have to be generated, but that's not difficult.

I agree with RLL that this situation does not involve a put option. To maintain S status, the company must automatically and immediately buy back any stock the ESOP distributes (as detailed in the Plan Document, of course). The company issues the check to the IRA or qualified plan. The redeemed stock then belongs to the company as RLL described in post #5.

If the distribution also includes cash for amounts not distributed as whole shares (partial shares, cash account balances, etc.), that portion of the distribution is made as you would make any cash distribution from the ESOP, e.g., a check from the trust. The total distribution amount (whole share value plus other cash) is reported on the 1099-R.

[QDROphile]

I did not say the other approach did not work or would have adverse tax consequences, only that if you want a direct rollover, you have to follow certain formalities about asset ownership.