Can employer make ESOP contributions in order to make distributions to

[Guest Bristol]

Could an employer make contributions to an ESOP in order to make distributions to participants who have terminated? Where in the Code or Regs. is this allowed or disallowed? Should the employer make an interest free loan?

[RLL]

An employer clearly may make cash contributions to an ESOP if the provisions of the ESOP plan documents permit cash contributions. I don't know where the Internal Revenue Code or regulations specify that this is permissible....it is so obvious that I've never looked for it. However, there may other agreements (such as loan covenants) that limit or restrict the employer's ability to make cash contributions to the ESOP.

The ESOP plan documents may require or permit the appropriate ESOP fiduciary to use cash contributions from the employer to make benefit distributions to participants. There may be circumstances, however, when it could violate ERISA fiduciary responsibility for an ESOP fiduciary to use cash contributions for benefit distributions. For example, using cash contributions allocated to all participants for making cash distributions with respect to employer stock allocated to a few participants may involve a fiduciary decision equivalent to buying shares of employer stock for the remaining participants.....which sometimes may be imprudent. Note that the ESOP fiduciary may be able to distribute benefits in shares of employer stock. If the stock is not readily tradable, it is the obligation of the employer, not the ESOP, to offer a put option and make cash available to the distributee.

Under a DOL class exemption from the prohibited transaction restrictions, it is permissible for an employer to make an interest-free loan to an ESOP to fund benefit distributions....so long as the appropriate ESOP fiduciary agrees to receive such a loan. Whether it is prudent at any particular time to use this alternative method for funding benefit distributions depends on the then prevailing facts and circumstances

[Guest Bristol]

If the employer makes a cash contribution,

What do you do with the stock from the terminated employees? Sell and allocate?

Do you ever allocate this contribution?

Plan document says that employer contributions are condition upon deductibility pursuant to sec. 404.

[RLL]

If the employer makes a cash contribution to the ESOP, the contribution is allocated among participants' accounts in accordance with the applicable allocation formula. If the cash is used to make benefit distributions to terminated participants, the cash is deducted from the remaining participants' accounts (usually in the same proportions that the cash contribution had been allocated) and is "replaced" in their accounts by the stock which had been previously allocated to the distributees. There is no reason to "sell" such stock...it is merely reallocated under the ESOP as a bookkeeping matter.

The employer contribution in cash is deductible under IRC Section 404(a)(3)....404(a)(1), to the extent it represents a money purchase plan contribution to the ESOP....subject to the applicable % of compensation deduction limits (and the Section 415 allocation limits).

Note that all employer contributions to an ESOP (or any other tax-qualified 401(a) plan) must be allocated as of a specified date for the applicable plan year and cannot be held unallocated or in suspense.

[Guest Bristol]

What if the employer contributions to an ESOP is not allocated as of a specified date for the applicable plan year and was never allocated, but put in a suspense account and invested in company stock?

[RLL]

If the employer contributions to the ESOP for a plan year are not allocated to participants' accounts, the ESOP would fail to be a tax-qualified employee plan under IRC Section 401(a). In addition, the ESOP fiduciaries would likely be violating ERISA by failing to properly allocate the company stock to the accounts of the participants.

[Guest Bristol]

What is the valuation date for participants who terminated?

Do you use the last valuation date prior to the distribution (12/31 valuation to make 3/31 distribution)?

[Guest hapa123]

What does the plan document say?

[Guest Bristol]

What if the amount involved were not contributions, but advances to the plan to make distributions. The intent, although not formalized, was to repay the advances. The distributions were made and the participants' stock were placed in a "separate" account. The number of transactions of this nature totals 5-7 over 10 years. The advances were never repaid and the value of the stock in the separate account has appreciated. How do you correct this problem?

[RLL]

Bristol --

Every time you come back with a posting on this matter your story changes and the problems get worse!

As a minimum, the appreciation attributable to stock in the "separate account" would probably be allocable to remaining participants' accounts, unless the ESOP plan document provides for some other treatment (and such document provision has been the subject of an IRS determination letter).

If the periodic "advances" have not been clearly documented as loans to the ESOP, they very well might be characterized by the IRS as employer contributions which have not been allocated.

The problems here are far too complicated to expect specific "correction" advise in a forum such as this. I recommend that the employer retain legal counsel with extensive experience in fixing ESOP administrative screw-ups.