Year-End Allocation Questions

[JMarsh]

Hello…I’m trying to create a model to project future balances for our participants but am running into a couple of roadblocks.

In past years, we have had 1 ESOP loan.  I reengineered the allocation calculation from our TPA and it seems that once we have an ESOP only allocation of contributions (after accounting for 415 limits and backing out 401k contributions), the loan is allocated to each participant to reduce the actual contribution amount paid.

Fast forward to 2024 and we will now have 2 loans due to a re-leverage.  When I use the same methodology to allocate the loans to participants, two of our participants have a negative contribution amount.  I’m not getting any clear answers from our TPA on how to handle this.

Similar to how 415 excess amounts are re-allocated to participants, would these negatives be re-allocated until no one is negative?

Furthermore, to make up for the fact that the bulk of our contributions are going toward loan payments, we will be doing an S-Corp Distribution in 2024.  S-Corp Distributions earned on allocated stock are allocated in proportion to participants based on beginning share balances less distributions and S-Corp Distributions earned on shares held in suspense are allocated based on Eligible Compensation.

What I’m unclear about is the timing.  Should contributions be allocated first, then S-Corp distributions, or vice versa?  I was going to model it out using both approaches, but the negatives caused by the loan impacted that original plan.

Thank you for your assistance.

Jeff

[MBESQ]

It’s not clear in your second paragraph how two participants can have a “negative contribution amount.” If this is due to Section 415 limits, the IRS has specific correction procedures.  You should consult with your attorney on this.

If the negative amounts are due  to the decrease in stock price due to the releveraging, generally keep in mind that ESOP loan allocations due to employer contributions derived loan payments involve share accounting.  When dividends or S corp distributions attributed to allocated shares are used for loan payments, the fair market value rule requires that participants receive an allocation of shares with a fair market value (FMV) at least equal to the cash that would have otherwise been allocated to their accounts.   

If the FMV allocation rule cannot be met, then there are compliance issues in using these funds for loan payments.  I would caution against using released shares from employer contributions to comply with the FMV rule, because the allocation method from this contribution source may deviate from the safe harbor non discrimination allocation method (such as a uniform percentage of compensation) and perhaps even the terms of the plan.  The FMW  rule for using allocated dividends and distributions for loan payments does not override other plan qualification rules.

You need to follow the terms of the plan document in making allocations.  One possible approach involves using distributions on unallocated shares to comply with the FMV rule, but it appears that a plan amendment would be required.  

 

 

[ESOP Guy]

I agree the 2nd paragraph is very confusing.  

It helps if you allocate loan payment dollars on each loan and release shares based on the ratio of the dollars. You need to know the value of the dollars and FMV of the shares for 415 depending on how the document is written.

Do the rest of the allocations like forfeitures if any. 

It almost sounds like you are allocating shares in dollar value and not shares.  ESOPs should always be done in share accounting as far as I am concerned.   Although that isn't a legal requirement.  It just is the best practice as far as I am concerned.  

You then compute your total Annual Additions for 415.  You correct per the document which might be in the 401(k) plan.   I don't see how a 415 failure can ever result in a negative allocation.  The worst you can get is no shares allocated to you.  You don't ever take shares from a person.  if they are still failing 415 and get no Annual Additions in the ESOP the problem is obviously in the other plan and it needs to be fixed there. 

Since the S Corp amount is fixed by the formula of the amount paid to the suspense shares you compute how much of the loan(s) payment(s) are paid by them.  The rest is contribution.  If there is more contribution made to the plan it is simply a cash contribution.   There might be exceptions to this but without seeing the actual facts I can't say. 

 

Remember you can only use Loan 1 S Corp distributions to pay that loan and same for loan 2.  You can NOT put all of them in one happy bucket and pay the loans.  You must track by loan vs their shares when doing the release. 

 

Bias alert:  I work for an ESOP specializing TPA firm.

 

Lastly, I am a bit concerned your TPA can't seem to help you more.  If your TPA firm that is helping your with your ESOP is just a 401(k) primary firm that is doing this work as a courtesy please think about getting a new ESOP TPA.   I know that can come across as self serving which trying to market around here is mostly considered bad form.  So that isn't my purpose.  ESOPs are a very specialized type of plan.  I cringe every time I am assigned to bring on a new client that came from a non-ESOP specialized firm or self administrated.   I would estimate 95-99% of the time they have a serious legal issue. 

What you are trying to do is something an good ESOP firm should be able to help you do.   Plenty of my firm's competitors and my firm could help you do this correctly and guide you through it all.   You need someone like that.