Contribution is too big

[Guest DennisT]

We have a leveraged ESOP client who is terminating the plan due to sale of the company. The yearly Employer contribution is $30,000 and there are two years left on the note. To pay off the note $60,000 must be contributed by the Employer but the § 415 limit is $28,000. What do we do with the "extra" $32,000. We want to treat it as dividends. Any suggestions? Are there any PLRs or TAMs on this subject?

[RLL]

Dividends paid on shares purchased by an ESOP with loan proceeds may be used to make payments on the loan. If the company is a C corporation, such divdends are deductible under IRC Sec. 404(k). If the company is an S corporation, Sec. 404(k) is not available and only dividends on the loan suspense account shares may be used for loan payments.

Depending on the timing of the transaction relative to the ESOP's Sec. 415 "limitation year," it may be possible to contribute the additional amount for a separate year within the 415 limits. If the plan documents and loan documents permit it, and if the appropriate ESOP fiduciary agrees, it may be possible to use a portion of the sales proceeds from the suspense account shares to pay the remaining loan principal balance.

The treatment of a leveraged ESOP in connection with the sale of a company can be a very complicated area, with many traps for the unwary. I recommend that you seek the advice of professionals experienced in such ESOP transactions.....which have become quite common in recent years.

It is too difficult to provide specific guidance in a forum such as this message board....the specific facts of your situation will likely determine the best course of action. There are many IRS PLRs addressing some of these issues...but no one PLR will tell you what approach will work for your client.

[MWeddell]

The IRS has usually required that the shares released from the suspense account be regarded as contributions, which are subject to a bunch of limits.

However, the IRS seemed to have a new position in a Technical Advise Memorandum publicized in the Dec. 1997 ESOP Report published by The ESOP Association, where it approved treating the released shares as investment gains. I've not been following this issue too closely since then, but suggest you contact the folks at The ESOP Association.

[RLL]

MWeddell is referring to an absurd position taken by the IRS National Office in a series of PLRs during the period 1993-97. This position was obviously incorrect, as it mischaracterized gains on the sale of employer stock as "annual additions" under IRC Sec. 415© and would have denied ESOP participants certain of the allocations resulting from gains on the sale of suspense account shares when an ESOP company is sold.

Finally, after years of repeated efforts by a number of ESOP professionals, along with The ESOP Association, and after a Tax Court case was initiated to challenge the IRS in the situation involving the 1997 TAM, the folks at IRS recognized their error and reversed the ridiculous position. A subsequent PLR in 1998 confirmed the IRS change in position.

When a situation involves a bona fide (and not "pre-arranged") sale of an ESOP company to an independent third party, there should no longer be a concern over the "415/suspense account shares" issue.

[QDROphile]

RLL: I found a 1998 PLR that had all the right facts for the ruling you describe, but it ruled only on the primary benefit issue. It stated that it would rule on two other issues under separate cover. I assume that one of the two other issues is the annual addition limit. But I have found no such published ruling in 1998 or 1999. Do you have a citation or other suggestion for finding the PLR that follows the TAM?

[RLL]

Do I have to do all your work for you?

If you're a member of The ESOP Association, you can check the monthly newsletter (ESOP Report). I know that the PLR was summarized in the "Legal Update" column shortly after it was released to the public. It was also mentioned in outlines of the "Legislative, Regulatory and Case Law Developments" presentations at The ESOP Association's Annual Conference and Two-Day Conference.

Also, it was in the similarly titled article in the Journal of Employee Ownership Law & Finance published by the National Center for Employee Ownership.

Maybe some other reader of this Message Board can find a cite for you....I'm too busy.