Use of cash in ESOP trust

[Guest svatty]

If an ESOP is established, and cash is contributed to it, but the cash is never used to purchase company stock does this raise qualification, tax and/or fiduciary issues?

Must the cash contributed to the ESOP trust be used to purchase company stock or make payments on a subsequent qualified loan within a specified time period?

Any help would be appreciated.

[Guest Larry Goldberg]

Yes. Since Section 4975(e)(7)(A) of the Code defines an ESOP as a plan that is designed to invest primarily in qualifying employer securities, the IRS could treat the plan as failing to constitute an ESOP if it never acquires company stock. Of course, the plan could be amended to become a profit sharing plan. In addition, Section 401(a)(23) of the Code requires that a stock bonus plan meet the distribution requirements of Section 409(h) of the Code. So, the failure by an ESOP to offer benefit distributions in the form of company stock could create a qualification defect. If the ESOP is a combination money purchase/stock bonus plan, the loss of ESOP status would cause the joint and survivor annuity rules to apply to the money purchase portion of the plan.

From a fiduciary standpoint, a trustee could not be faulted for the failure to invest the plan's cash into company stock if there is no shareholder willing to sell stock to the plan. With respect to a delay in the use of cash contributions to make a loan payment, the ESOP loan regulations appear to contemplate that a cash contribution which is ear-marked for use as a loan repayment could be held in the trust and used in a future year to make a loan payment (See 54.4975-7(B)(5) final paragraph).

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[RLL]

I don't think an ESOP can use prior accumulated funds attributable to employer contributions to make payments on a subsequently incurred ESOP loan. How can the contributions be "made for the purpose of repaying a loan" that doesn't exist (and may never exist) at the time of the loan? Reg. Sec. 54.4975-7(B) would make such use of prior employer contributions a violation of IRC Sec. 4975 and ERISA Sec. 406.

[Guest Larry Goldberg]

I agree that the loan must be in existence at the time the contribution is made. The regulation refers to " . . . contributions . . . that are made under an ESOP to meet its obligations under the loan . . . . " A contribution made before the loan is incurred would not meet this requirement.

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