use of employee deferrals to repay KSOP loan

[Guest beth beaube]

I have a client that wants its KSOP to borrow money from a bank to allow the KSOP to purchase additional employer securities. Once those employer securities are purchased, the loan would be paid back with a combination of employee deferrals and employer contributions (that is, employee deferrals would be used to purchase the employer stock from the KSOP such that the stock would be allocated to the participant's account and the cash would be used by the KSOP to repay the loan). The employer does not want to repay the loan only with employer contributions because the employer sees this as unfair. Is this OK?

[RLL]

The IRS position (reflected in a TAM) appears to be that Reg. Section 54.4975-7(B) permits the use of elective deferral contributions for payments on an ESOP loan. Several years ago, the DOL requested that IRS change its position....but there is nothing to indicate that IRS has done so. The Reg. allows ESOP loan payments from contributions made for the purpose of repaying the loan. So long as there is appropriate disclosure (under both ERISA and applicable securities laws) to participants that elective contributions are being applied to loan payments, there can be compliance with the ESOP loan regs (both under the IRC and the DOL regs under ERISA). Of course, ERISA Sec 404(a)(1) will still apply to the fiduciary decisions involved, and such use of elective deferrals must be authorized under the plan documents (and specified in the SPD).

[This message has been edited by RLL (edited 07-01-99).]

[Kirk Maldonado]

I would expand somewhat your remark about the obligations arising under securities laws as a result of the use of the participant contributions to repay the loan. You need to determine whether the use of employee contributions under those circumstances complies with both federal and state securities laws. If there isn't an applicable exemption, compliance with the securities laws can be costly, often prohibitively so.

[Guest ESOPwizard]

The DoL takes the position that using 401(k) contributions to repay a loan is a prohibited transaction. I do not believe that that position is correct. Nevertheless, a number of attorneys apparently do. Last time I suggested to a client that they use 401(k) contributions to make loan payments their big name DC attornay told them that it would be a prohibited transaction. I recommend that you consider the prohibited transaction issue before amending the plan.