Funding ESOP Distributions

[Guest sjlbenefits]

A 100% ESOP-owned S-Corporation has been asked by former employees to make distributions from its leveraged ESOP before the ESOP loan matures in 2014. The plan document does not require payment until the end of the plan year following the plan year in which the ESOP loan matures. The plan document further provides that distributions may be made in cash or stock, in the sole discretion of the ESOP trustee.

(1) Can an S-Corporation defer distributions until the ESOP loan matures? I know that it is permissible for a C-Corporation to delay distributions, but I read an article that stated that distributions may not be delayed for an S-Corporation, but there was no citation of authority for the statement.

(2) The S-Corporation plans to contribute to the ESOP sufficient cash to fund the distributions. Will the contribution of cash be considered a distribution from the S-Corporation (rather than an ESOP contribution) to the 100% owned ESOP? Will this funding result in the allocation of shares from the suspense account to participant accounts, just as it would for a loan repayment made to the ESOP?

(3) If the ESOP Trustee makes the distributions in the form of stock rather than cash, is there capital gains treatment which would be more advantageous to participants when compared to a distribution in cash? Does the capital gains treatment apply all shares that are distributed? I read somewhere about capital gains treatment applying to a portion of a distribution and it wasn't clear if the portion not eligible for capital gains treatment was due to fractional shares being paid out in cash, or if the capital gains treatment was only available for a portion of the stock distributed.

(4) If the ESOP Trustee distributes stock, subject to a put option, and the S-Corporation buys back the stock, does the S-Corporation contribute the treasury stock back to the ESOP so that the S-Corporation continues to be 100% ESOP-owned? Does this contribution of stock result in an allocation to participant accounts equal to the FMV of the stock contributed?

I appreciate any information that you can provide.

[Guest tmills]

I won't pretend to have all the answers, but maybe at least this will get the conversation going.

1. From what I've read, it's a grey area. However, if your plan document says that is what will happen and it has an IRS letter, I don't see a real problem.

2. Putting cash in the esop will be a contribution. Shares will be released from suspense if the cash is used to make a loan payment. Does the company intend to make an additional contribution sufficient to make the loan payment? Again, the document is key here. Does the plan allow cash contributionsin the event of an outstanding loan that are not used to make loan payments? Is there any kind of restrictin on cash contributions that they can't be used for stock purchases (I would classify the reshuffling as a stock purchase, others may not.)

3. You are talking about NUA treatment. There is plenty of recent discussion about that on the board that doesn't need to be repeated here. With an S Corp, the key thing regarding NUA is the proper calculation of basis. Easier said than done.

4. Whether the corporation keeps the shares as treasury or contributes them back does not effect the esop's status as a 100% owner. If the shares are contributed back they need a valuation as of the contribution date. They would be allocated as a contribution.

[GMK]

With an S Corp, the key thing regarding NUA is the proper calculation of basis. Easier said than done.

True that.

As a reminder, with an S corp, the pass-through earnings add to the basis of the shares in the ESOP, and the calculations look at each time the number of shares in any account changes. Almost impossible to do the calcs on a slide rule, but a spread sheet helps.

And as far as I know, the rest of what tmills said is right. (Tho' I don't know if reshuffling is a stock purchase, the plan document is your key guide regarding cash contributions and stock releases and allocations.)