ESOP Conversion to Profit Sharing Plan and Cutback Questions

[7806akp]

We are considering converting an ESOP to a profit sharing plan and redeeming all the employer stock in the plan for cash. Is there any reason why this would not be allowed under section 409? After the conversion of the ESOP to a profit sharing plan and the redemption of the employer stock for cash, the employer would like to amend the plan to eliminate the option to receive distributions in employer stock. Would this violate the section 411(d)(6) cutback rules or does Reg. sec. 1.411(d)-4 Q&A-2(b)(2)(iii)(A) provide an exception to the cutback rules that would be applicable in this situation? Does an ESOP that converts to a profit sharing plan continue to be subject to the section 409(h) distribution requirements?

[RLL]

Under many circumstances, an ESOP can be "converted" into a profit sharing plan; and various ESOP features (such as the 409(h) distribution requirements) can be eliminated, per IRC section 411(d)(6)© and the corresponding provision of Title I of ERISA. This must be done with great care and should be done only with advice of legal counsel experienced in ESOP matters. The IRS has been issuing favorable determination letters with respect to such plan changes for many years.

The biggest concern is the proposed redemption of employer stock. The employer may not unilaterally decide to redeem the stock. The decision as to whether (and upon what terms) the ESOP will sell its stock to the employer should be made only by an ESOP fiduciary that is independent of the employer. The transaction price must be not less than fair market value, as determined by an independent appraiser (if the stock is not publicly traded), on the date of the redemption.

In addition, attention should be given to the delicate task of communicating this change to the participating employees.

[7806akp]

Under many circumstances, an ESOP can be "converted" into a profit sharing plan; and various ESOP features (such as the 409(h) distribution requirements) can be eliminated, per IRC section 411(d)(6)© and the corresponding provision of Title I of ERISA. This must be done with great care and should be done only with advice of legal counsel experienced in ESOP matters. The IRS has been issuing favorable determination letters with respect to such plan changes for many years.

Thank you for your response. You stated that coversion must be done with great care. What pitfalls should be avoided and what issues should we consider? It seems that Reg. sec. 1.411(d)-4 Q&A-2(b)(2)(iii)(D) Example (1) would allow an ESOP (1) to first be amended to be a profit sharing plan and to remove the employer stock fund as an investment option under the plan and (2) later, after the plan has ceased to provide for an employer stock investment option and all plan accounts only contain cash, to be amended to eliminate the right to a distribution in the form of employer stock. Do you have any thoughts on this?

Also, I am curious, is there a way to look at other plans' determination letter applications to see what arrangments have been approved by the IRS?

[RLL]

I stated above that "This must be done with great care and should be done only with advice of legal counsel experienced in ESOP matters."