ESOP Annual Additions Value Reporting: At contribution date or allocat

[Guest gkaley]

In an (non-leveraged) ESOP that contributes a certain dollar amount at mid-year to the ESOP trust, but does not allocate the contribution across participant accounts until year end, what is reported as Sec. 415 Annual Additions for participants? The value at time of contribution, or the value at time of allocation.

This can have many potential plan reverberations, since the assets in the trust could potentially be invested in a supplemental fund within the ESOP trust - i.e. money market. Then, would income from that investment be required to be allocated to participant accounts?

[RLL]

Hi gkaley ---

Annual additions under IRC Section 415© for all defined contribution plans [including ESOPs] are based on the actual amount of cash contributed or the value of property (including company stock) contributed, determined as of the contribution date.

To the extent that there are earnings on contributions (or the value of a contribution in property has changed) as of the allocation date, the difference represents investment income (or loss). Any such investment income (or loss) must be allocated to participants' accounts in accordance with the terms of the plan documents, and the amounts so allocated (as investment income) are not annual additions under Section 415©.

[Guest gkaley]

RLL,

Thank you for responding. But your answer prompts a follow-up question...

Example:

June 30 - Valuation Day

Employer Stock = $50. Hence, employer contributes $50 to the trust on behalf of participant A on June 30.

December 15 - Allocation Day

Employer Stock has lost value to $25. Employer allocates $25 to participant A's account (Plus investment earnings from the trust). Yet, $50 must be included in participant A's Annual Addition calcuation?

[RLL]

gkaley---

Good question! Surprisingly, the answer is "yes"...there is a $50 annual addition. See Reg. Sec. 1.415-6(B)(4).

[Guest gkaley]

RLL,

Thanks for taking the time. I do appreciate it.

[Guest gkaley]

However...I did notice that 1.415-6(B)(4) makes reference to "...property other than cash." The example above is making a cash contribution to the trust based on the present valuation of the stock. The cash is not buying ESOP shares until time of allocation. Is this still considered a non-cash contribution because of the allocation of ESOP shares at the time of allocation? Or is the contribution considered cash at the time it's made to the trust?

[RLL]

gkaley ---

Cash is cash.

A cash contribution of $50 in June results in $50 of annual additions when allocated to participants' accounts in December. It doesn't matter (for purposes of Section 415) how the $50 is invested during the June-December period. In determining annual additions, you count the $50 cash contribution not the stock purchased (with the $50) and allocated to participants' accounts.

[Guest gkaley]

RLL,

Now I am confused. Your previous instructions regarding 415 limits and an ESOP contribution made 6-months prior to allocation to participant accounts, referred me to Reg. 1.415-6(B)(4). But that reg refers to non-cash contribution fair market value.

Now you are saying "cash is cash" so that reg wouldn't apply here would it? Or am I missing something?

Even so, I'm concerned about the un-allocated earnings. It seems to me that there would be a "prohibited transaction" interpreted here.

Let me be more specific about my potential arrangement...

Plan A sponsors an ESOP. Plan A determines the value of stock A-1 on 6/30 and contributes $50 (per participant) to the ESOP trust based on that valuation. However, said contribution is not allocated to participant accounts, but invested in a money-market. At 12/15, money-market investment has gained $2,000 and ESOP valuation is now $25.

1. $50 is included in annual addition? Why?

2. Can un-allocated income (from MM investment) be carried in a trust?

3. Would this be the outcome: Participant receives $25 allocation to the ESOP on 12/15. Participant receives share of money-market investment income of $2.50. Participant has $50 counted toward annual addition limit. And if that $50 brings the participant over the 415-threshold, they will have an excess due...even though they only actually received $25 on 12/15?

4. Is this a prohibited transaction?

5. Are you aware of any private letter rulings that may apply aptly?

I'm overtly skeptical of the arrangement, but the plan sponsor is adamant about using it.

[RLL]

gkaley ---

When a contribution is made to an ESOP in cash, there is no valuation issue....the amount of cash contributed will become IRC Section 415© annual additions to participants as of the allocation date....even if the cash is invested, generates earnings and results in allocations to participants in amounts greater than the amount of contributed cash.

With regard to your potential arrangement, you now have me confused. In order to try to clear this up, here are my responses:

1. The annual addition is $50 because the contribution was $50. The value of the stock is not relevant under Section 415 because stock was not contributed.

2. All income of the ESOP trust must be allocated to participants' accounts at least annually.

3. The amount actually allocated to the participant would be the $50 contribution (which is also the annual addition), plus the $2.50 income.

But how could the money market investment of $50 earn $2.50 in less than 6 months? That's better than a 10% annual return!

Under your facts, the change in the value of company stock is not relevant. The ESOP doesn't have stock until the contributed cash (and earnings) are used to purchase company stock.

4. There is no prohibited transaction....the ESOP has merely received a cash contribution and invested it in a money market fund. No company stock has been purchased by the ESOP and the ESOP has not suffered any loss.

5. This conclusion is obvious....unless you've misstated the facts. There is no need to look at any PLRs for this.

Have you left out a step? Has the ESOP purchased company stock? Was the June contribution made in shares of company stock? If cash is contributed in June, what relevance is there in looking at the then value of company stock?

[pjkoehler]

gkaley, the regs provide that cash contributions used to acquire employer securities are treated as employer contributions for annual additions computation purposes for the limitation year in which they are contributed if: (1) the employer actually contributed the cash within 30 days of the taxable year with or within which the applicable limitation year ends and (2) the employer securities are acquired no later than 60 days after the end of such period.

See Reg. Sec. 1.415-6(g)(4)(i).

There is an unpublished TAM (March 14, 1997) that appears in Worksheet 14 of the BNA on ESOPs. It deals with the treatment of the appreciation of shares held an ESOP suspense account as "earnings" for 415 purposes, i.e. they are not treated as annual additions. Although this is not on point, and unpublished TAM is scant guidance, you could probably argue that the logic of the conclusion should also apply in the treatment of "earnings" on the plan's non-employer securities assets.

As far as PT issues: I fail to see any nonexempt transaction in plan assets that involves a party in interest or a transaction in which a plan fiduciary is using the discretionary authority that makes it a fiduciary to engage in a a "self dealing" type of transaction. Thus, your fact pattern presents no PT issues. You might be thinking of a fundamental qualification requirement set forth in Reg. Sec. 1.401-1(a)(3)(iv) (the exclusive benefit rule). But this, of course, is a qualification issue, not a PT issue, and the way you've described the plan, the trustee has no discretion in the determining the timing of the acquisition or even the investment medium of plan assets held in nonemployer securities. I think it would be a stretch to argue that the deferred purchase is therefore questionable on "exclusive benefit" grounds.

[RLL]

Hi PJK ---

Reg. Section 1.415-6(g)(4) provides the special rules for dealing with the increased dollar limitation that formerly was available to ESOPs under IRC Section 415©(1)(A). That provision of the Code was repealed by Congress (in the late 1980s) and is no longer applicable.