ESOP shares

[Bird]

For purposes of determining ownership, are ESOP shares counted? We have a disagreement here...

[Bird]

Perhaps this needs clarification. We have a company with a 401(k) plan, and they started an ESOP. We are trying to determine ownership for HCE/key determination. I believe we attribute the ESOP ownership (and think I found the appropriate reference in Who's The Employer) but an ERISA attorney says no. (I did not present this to him and it is possible the question was garbled.)

[C. B. Zeller]

For Key/HCE determination purposes, I believe the answer is no. Ownership is attributed under 318 for Key/HCE determination, and 318(a)(2)(B)(i) excludes stock owned by a qualified plan trust.

Since you have access to Who's the Employer, also see chapter 13, example 13.3.17.

[ESOP Guy]

For Key and HCE purposes the shares in a person's account in an ESOP do NOT count.

The cite above is good.  Also think of it this way the shares are legally owned by the ESOP trust not the participant.  They are a beneficiary of the ESOP trust and they have little say over how those shares vote for example.   There is only a narrow set of events the participants in an ESOP must be given the right to vote "their" shares.   

[Peter Gulia]

Although it does not affect how the law cited above applies, consider too that many ESOPs, especially many designed to invest in shares of a corporation with subchapter S income tax treatment, preclude a participant from ever getting shares, even for a distribution.

[Bird]

Thanks all. I have no experience at all with ESOPs and appreciate the feedback. It makes more sense now.

[Tom]

I asked this same question a year or two ago. The plan sponsor is 100% owned by an ESOP.  I received the same answer as above - good to see!   It was mentioned as well - while there is no ESOP ownership attributable to anyone at the employer/sponsor, the employer/sponsor of the plan still may have officers who qualify as a key employees for top heavy testing and HCEs base on prior year compensation triggering the various nondiscrimination testing.   This plan sponsor has 300 participants and they only fund deferrals and so this was a topic that gave me some significant concern.  

Family attribution would not apply here since there are no HCEs or Keys due to ownership.  There is no family attribution to HCE/Key based solely on being an officer or HCE due to prior year comp - right?  :🤔

[Gilmore]

Thanks Bird for this question.  Timely for us, too as we just experienced a similar situation.  Am I correct in the following fact pattern?

Two 50%, long time owners.  In June 2022, ownership is transferred 100% to a new ESOP.  Both have non-owner spouses in the plan.  They are the only officers, and exceed the comp limit each year.  

Assuming ESOP continues to maintain 100% ownership, and prior owners continue to be the only officers.

For 2022, both owners and the spouses are considered to be 5% owners.

For 2023, both owners and the spouses are considered to be 5% owners (looking back to 2022).

For 2024, no 5% owners.  Prior owners, as officers exceeding the comp limit are Key Employees.  Spouses, as non-officers are now former key employees.

Does that all sound appropriate?

Thanks very much.

[Paul I]

The above comments about 5%-owners address issues for determining HCEs and Key Employees.  There potentially is a whole other set of rules tied to ownership if the corporation an S-corp. 

If it is an S-corp, then you will need to track ownership to identify Ineligible Persons.  If the sum of ownership of all Ineligible persons is 50% or more, the plan will have to address a nonallocation year for the ineligibles including impermissible accruals and impermissible allocations, plus some tough tax consequences.

The shares actually allocated to an individual in their ESOP account, plus "deemed owned" shares which are a proportion of unallocated shares, e.g., in the suspense account, are added together to see if an individual is deemed to own more than 10% of the company.  Toss in some family aggregation rules (that are similar to but not the same as 5%-owner attribution rules) for some extra complexity.

Any synthetic equity such as stock options, warrants, restricted stock, deferred issuance stock right, that give a participant the right to obtain more stock in the future also are added into the deemed owned number of shares.

This can get complicated, but an S-corp that is 100% owned by an ESOP passes through all of its income to a qualified plan.

[Gilmore]

Thank you for the additional information Paul.  Do the issues you are addressing have carry over to say a separate 401(k) plan, or are these specific to the ESOP?

[ESOP Guy]

On 2/24/2023 at 11:40 AM, Gilmore said:

Thanks Bird for this question.  Timely for us, too as we just experienced a similar situation.  Am I correct in the following fact pattern?

Two 50%, long time owners.  In June 2022, ownership is transferred 100% to a new ESOP.  Both have non-owner spouses in the plan.  They are the only officers, and exceed the comp limit each year.  

Assuming ESOP continues to maintain 100% ownership, and prior owners continue to be the only officers.

For 2022, both owners and the spouses are considered to be 5% owners.

For 2023, both owners and the spouses are considered to be 5% owners (looking back to 2022).

For 2024, no 5% owners.  Prior owners, as officers exceeding the comp limit are Key Employees.  Spouses, as non-officers are now former key employees.

Does that all sound appropriate?

Thanks very much.

That would be my take on the facts above.   

[ESOP Guy]

3 hours ago, Gilmore said:

Thank you for the additional information Paul.  Do the issues you are addressing have carry over to say a separate 401(k) plan, or are these specific to the ESOP?

What Paul is addressing is 409p testing.  It is very complex.  At the risk of coming across as a bit self serving but failing 409p can't happen.  You need to get solid advice from an ESOP service provider who knows what they are doing to help you with the 409p rules.  The family attribution in 409p is much broader than any other testing.

But no it doesn't apply to 401k plans.  

[Gilmore]

1 hour ago, ESOP Guy said:

What Paul is addressing is 409p testing.  It is very complex.  At the risk of coming across as a bit self serving but failing 409p can't happen.  You need to get solid advice from an ESOP service provider who knows what they are doing to help you with the 409p rules.  The family attribution in 409p is much broader than any other testing.

But no it doesn't apply to 401k plans.  

Got it, thanks very much.  We do not handle the ESOP and I'm thinking eventually the ESOP provider will take over the 401k as well.  Just want to make sure we keep it in good order until it goes.

[Paul I]

ESOP Guy, you are not being self-serving because failing 409p really is not an option. 

Gilmore, 401(k)s and S-corp ESOPs are very different.  I believe you will find ESOP service providers who will work closely with you where you continue to service the 401(k) and they will service the ESOP.  In can be a win-win-win for the plan sponsor, for you and the ESOP provider.

[Gilmore]

6 minutes ago, Paul I said:

Gilmore, 401(k)s and S-corp ESOPs are very different.  I believe you will find ESOP service providers who will work closely with you where you continue to service the 401(k) and they will service the ESOP.  In can be a win-win-win for the plan sponsor, for you and the ESOP provider.

Thanks.  Up to the client of course, and I believe they are looking to keep everything with one provider, which is understandable.