Parent adopting on behalf of a subsidiary

We have two companies, A and B.  A is the parent, but has no employees.  B is the subsidiary that actually has employees.  In the interest of time, we'd like to have A adopt a 401(k) plan that would cover B's employees, rather than having B sign a separate participation agreement.  Does anyone have any authority as to whether this works?

Some aspects of what you ask involve the public and private law of the business organizations involved. A parent, intermediate parent, or even ultimate parent acting for a direct or indirect wholly-owned subsidiary is usual for many business groups. But you (or your client’s inside counsel) would trace through the ownership interests, formation documents, and bylaws, LLC, or partnership agreements to satisfy yourself that A has power to act for B.

If the plan sponsor would use IRS-preapproved documents, consider how to make A’s acts and B’s acceptances fit the form of the documents. A service provider’s plan-documents set might impose conditions beyond those applicable public law calls for.

I’m unaware of an on-point court decision.

Observe that ERISA § 3(5) defines “employer” to include “any person acting directly as an employer, or indirectly in the interest of an employer[.]”

For what it's worth, we have followed this structure many times with ESOP-owned companies--including receiving initial and termination determination letters--without any resistance from the IRS.

In those cases, the parent company sponsors the ESOP and is a holding company with no employees. The parent company stock is used as the ESOP's employer securities. The operating business and all employees are housed in a wholly owned subsidiary (or subsidiaries). The operating subsidiary joins the holding company's ESOP as a participating employer.

Edit: Just re-read the original post, which mentions not wanting to execute a participation agreement. Sorry. 

On 7/19/2024 at 3:32 PM, EBECatty said:

For what it's worth, we have followed this structure many times with ESOP-owned companies--including receiving initial and termination determination letters--without any resistance from the IRS.

In those cases, the parent company sponsors the ESOP and is a holding company with no employees. The parent company stock is used as the ESOP's employer securities. The operating business and all employees are housed in a wholly owned subsidiary (or subsidiaries). The operating subsidiary joins the holding company's ESOP as a participating employer.

Edit: Just re-read the original post, which mentions not wanting to execute a participation agreement. Sorry. 

Have you run across a situation in the M&A context where buyer of a 100% ESOP S corp is wanting the S corp to go through an F Reorg?  Any issues with converting the operating company below the S corp to an LLC for purposes of the F reorg immediately before closing?

No, but from the ESOP's perspective it converts the transaction from a stock sale (the ESOP trust as the S corp's shareholder selling the S corp stock to a buyer) to an asset sale (the S corp selling its assets, the LLC interests, to the buyer).

To the buyer, and for purposes of the deal documents, it's still a stock sale of the operating business, so this shift can be easily overlooked. 

The rub is that a stock sale generally does not require a pass-through ESOP participant vote, whereas a sale of substantially all assets generally does. This changes the entire dynamic of the deal, so is difficult to decide to do/change at the last minute (i.e., when buyer's accounting firm discovers some miniscule S corp infraction from 20 years ago and panics...).

10 minutes ago, EBECatty said:

No, but from the ESOP's perspective it converts the transaction from a stock sale (the ESOP trust as the S corp's shareholder selling the S corp stock to a buyer) to an asset sale (the S corp selling its assets, the LLC interests, to the buyer).

To the buyer, and for purposes of the deal documents, it's still a stock sale of the operating business, so this shift can be easily overlooked. 

The rub is that a stock sale generally does not require a pass-through ESOP participant vote, whereas a sale of substantially all assets generally does. This changes the entire dynamic of the deal, so is difficult to decide to do/change at the last minute (i.e., when buyer's accounting firm discovers some miniscule S corp infraction from 20 years ago and panics...).

Good feedback, all things I agree with.  Only other question I have is that during the F Reorg process whereby the S corp (owned by the ESOP) drops its assets down into a subsidiary that ultimately converts to an LLC (taxed as a partnership) immediately before closing...does that create any qualification issues for the ESOP as the LLC would no longer be in a controlled group with the ESOP due to being taxed as a partnership?

Wouldn't the LLC be a disregarded entity (wholly owned by the S corp) and not a partnership? If a DRE, no problem. 

4 hours ago, EBECatty said:

Wouldn't the LLC be a disregarded entity (wholly owned by the S corp) and not a partnership? If a DRE, no problem. 

In some circumstances yes, in other circumstances the LLC wouldn't be a disregarded entity and would be a true pass through LLC entity.  I think that would be problematic for the ESOP under 409(l).

Agree that an operating business (employing ESOP participants) that's taxed as a partnership and owned (in part) by an S corp (in turned owned by an ESOP) would be a problem under 409(l). If you already have a 100% S corp ESOP, how would an F reorg get you a lower-tier partnership with other owners?

Typically, the F reorg is (1) shareholders of S corp 1 form new S corp 2; (2) shareholders of S corp 1 contribute 100% of S corp 1 stock to S corp 2, in exchange for pro rata stock ownership in S corp 2; (3) S corp 1, now a wholly owned sub of S corp 2, becomes a Q sub then converts to an LLC; (4) S corp 2 then sells 100% of equity of LLC (formerly S corp 1). 

Whether you have one original S corp shareholder or multiple shareholders, the resulting LLC is wholly owned by the newly formed S corp 2, no? If S corp 2 owns 100% of an LLC (that has not elected to be taxed as a corporation), wouldn't it be a DRE by default?

Unless you introduce new owners to the LLC after the reorg.

Hope I'm not missing something. 

On 11/1/2024 at 4:59 PM, EBECatty said:

Agree that an operating business (employing ESOP participants) that's taxed as a partnership and owned (in part) by an S corp (in turned owned by an ESOP) would be a problem under 409(l). If you already have a 100% S corp ESOP, how would an F reorg get you a lower-tier partnership with other owners?

Typically, the F reorg is (1) shareholders of S corp 1 form new S corp 2; (2) shareholders of S corp 1 contribute 100% of S corp 1 stock to S corp 2, in exchange for pro rata stock ownership in S corp 2; (3) S corp 1, now a wholly owned sub of S corp 2, becomes a Q sub then converts to an LLC; (4) S corp 2 then sells 100% of equity of LLC (formerly S corp 1). 

Whether you have one original S corp shareholder or multiple shareholders, the resulting LLC is wholly owned by the newly formed S corp 2, no? If S corp 2 owns 100% of an LLC (that has not elected to be taxed as a corporation), wouldn't it be a DRE by default?

Unless you introduce new owners to the LLC after the reorg.

Hope I'm not missing something. 

Thanks again - very helpful.  One last question to bounce off you if you don't mind, if the Buyer wants to make a 338(h)(1) or 336(e) election would that cause the Trustee to have to pass through the vote to the ESOP participants?  Those elections would cause the transaction to be treated as a deemed asset sale for federal income tax purposes.  Or are we able to maintain the position from the ESOP’s perspective that it is a stock sale even though an election is made to treat it as an asset sales for federal income tax purposes?

Can't point to anything specifically addressing that issue off-hand (others might be able to) but the 409(e) pass-through voting requirements generally are based on the relevant state's corporate law governing shareholder approval of corporate transactions (i.e., if the controlling state's corporate law requires a shareholder vote, the 409(e) rules generally would require a pass-through vote).

I wouldn't think a buyer's federal tax election would impact the voting requirements of the underlying state corporate law, which generally would follow the form of the actual transaction.