ESOP - UBIT Shares

[katiejoseph]

I am curious to hear the group’s thoughts on what to do about UBIT shares (that is, shares in an S-corp that were long ago transferred from an ESOP to a non-ESOP portion of the plan in order to avoid a failing 409(p)).

Here are the ideas we've come up with so far:

1.       Have the trustee sell the UBIT shares to the employer.

2.       Provide NHCEs with a one-time, voluntary election to use cash allocated to their accounts in the ESOP portion of the plan to purchase UBIT shares, with purchased shares returning to the ESOP portion of the plan, and tracked so that they are not re-allocated to disqualified persons. 

3.       Add an in-service distribution option to the non-ESOP portion of the plan.

I am curious to hear thoughts on the following:

•        Do you read CCA 201747007 as precluding option 2?  We had a client do something similar years ago and get a determination letter on it, but that occurred before the CCA came out.

•        If all of the participants in the non-ESOP portion of the plan are HCEs, we think there’s a 401(a)(4) problem with option 3, since the ESOP portion of the plan will not offer the same in-service distributions.  We do not think Treas. Reg. § 1.409(p)-1(b)(2)(v)(B) addresses the problem. Other than adding the same in-service distribution to the ESOP portion of the plan, do you see a way out of the 401(a)(4) problem?

•        Any other ideas? If so, have you gotten a determination letter on them? 

[Degrand]

ESOP companies usually use option 1 and the company may contribute the shares back into the ESOP.  Option 2 doesn't work for two reasons.  The investments in the ESOP are not participant directed.  The investment in the stock doesn't meet an exception under the securities laws.  While 409p may be an HCE issue, it isn't always the case.  I have seen the IRS during an audit accept an in-service distribution of UBIT shares without questioning 401(a)(4) issue.  However, it might have been because the stock usually went up 10-15% each year.  The distribution of the stock wasn't looked at a favorable outcome to the participant.