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Answers are provided by S. Derrin Watson, JD, APM
Controlled group determination for ESOP that covers owner of plan sponsor
(Posted July 20, 2000)
Question 53: This is a folow-up to Q&A-22. Company A establishes an ESOP. The ESOP takes a loan to acquire 100% of the stock of Company A. The ESOP has 5 participants, one of which ("Evan") owns 100% of Company B. Initially, the stock acquired by the ESOP is held in a suspense account and is not allocated to the participants' accounts. Allocations will not be made until the loan is paid down. How is Evan's stock ownership determined for purposes of analyzing the existence of a controlled group?
Answer: Interestingly, allocation is not the major issue here. Start with the idea that a retirement trust is simply a trust as far as the attribution provisions are concerned, at least for retirement plans (see Q&A-22 for more details). Under IRC 1563, what matters is a trust beneficiary's actuarial interest in the trust. You start with the notion that a beneficiary who has a beneficial interest of 30% of the trust is deemed to own 30% of the assets, and hence 30% of the stock of A.
The regulations go further, however. They say:
Stock owned, directly or indirectly, by or for an estate or trust shall be considered as owned by any beneficiary who has an actuarial interest of 5 percent or more in such stock, to the extent of such actuarial interest. For purposes of this subparagraph, the actuarial interest of each beneficiary shall be determined by assuming the maximum exercise of discretion by the fiduciary in favor of such beneficiary and the maximum use of such stock to satisfy his rights as a beneficiary. A beneficiary of an estate or trust who cannot under any circumstances receive any interest in stock held by the estate or trust, including the proceeds from the disposition thereof, or the income therefrom, does not have an actuarial interest in such stock. (Treas. Reg. section 1.1563-3(b)(3)(i).)
So, if there are assets that cannot be used to satisfy a beneificiary's interest, they aren't counted. On the other hand, a beneficiary who is entitled to more than his percentage interest of a particular asset is deemed to own that.
Take, for example, a retirement trust with two beneficiaries, John and Mary. John's beneficial interest is 60% of the trust and Mary's is 40%. Absent specific allocations, John is deemed to own 60% of any stock held in the trust.
But suppose Mary has 100% of XYZ company stock allocated to her account, which can be used only for her. She is deemed to own 100% of that asset and John none.
Now, we come to one other rule, trustee discretion. If the trustee has discretion over how stock will be allocated, it is assumed he will use that to the maximum extent for each beneficiary.
Suppose you have stock valued at $10,000 and other assets valued at $90,000. These assets are not allocated to any beneficiary. If the trust were to liquidate, the trustee would have discretion as to what is allocated to who. If either party received a distribution, they could receive all of the stock in the distribution. Under these circumstances, John and Mary will each be deemed to own 100% of the stock, because the trustee has the discretion to use 100% of it for their benefit.
The bottom line is that the stock is going to be deemed to owned by the beneficiaries, even if it is not allocated to their accounts. In fact, the uncertainty can give rise to multiple beneficiaries being deemed to own the stock, depending on the circumstances.
(Attribution under IRC 1563 is discussed in detail in Chapter 7 of my book, Who's the Employer?.)
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