Today, Donald Kieffer and Michelle Owen of the Employee Plans branch of the Internal Revenue Service (the "IRS") conducted a Phone Forum focused on the latest issues arising out of the ESOP determination letter process. This article is a summary of some of the items discussed.
On September 19, 2011, the Employee Benefits Security Administration ("EBSA") of the Department of Labor ("DOL") announced it would reconsider and re-propose its regulation that would have included ESOP appraisers in the definition of "fiduciary " for ERISA purposes. ESOP-owned companies, along with The ESOP Association, the National Center for Employee Ownership and the Employee-Owned S Corporations of America voiced a number of objections to the proposed regulations, most importantly citing the significant negative impact the proposed regulation would have on the formation of new ESOPs, and the increased costs of operating existing ESOPs.
A district court in Arizona has upheld an ESOP Committee's decision to amend the timing and manner in which terminated employees' company stock accounts are converted to other investments. Prior to the amendment, the ESOP provided the committee with the discretion at any time to "determine (based upon a nondiscriminatory policy) that the Accounts of former Employees will be diversified and invested in Trust Assets other than [Company] Stock." The district court found that the Committee's actual practice was to convert investments as soon as the ESOP had sufficient cash to do so. The amendment in May 2007 provides that a terminated participant's company stock will be converted to other investments effective at the end of the plan year in which the participant terminates employment. The plaintiff was a participant who was considering whether to participate in a reduction in force (RIF) in September 2006. The plaintiff was told by a member of the Committee that it would take approximately two years for the account to be converted. Since the plan year ended in September, the plaintiff expected her account would not be converted to other investment until 2007 or 2008. When the Committee amended the policy in May 2007, the change was applied to all terminated employees, and so the plaintiff's account was converted as of September 30, 2006. The plaintiff filed the lawsuit seeking the increase in the stock value from 2006 to 2007.
In Quan v. Computer Sciences Corporation, No. 09-56190, D.C. No. 2:08-cv-02398-SJO-JWJ, September 30, 2010, the Ninth Circuit has made clear it will apply the so-called Moench presumption in favor of fiduciaries who manage employer stock investments for 401(k) plans and ESOPs.
Today, Robert Gertner and Claire Diefenbach of the Employee Plans branch of the Internal Revenue Service (the "IRS") conducted a Phone Forum focused on the issues arising out of the ESOP determination letter process. The IRS focused on two of the Technical Assistance ("TA") requests released earlier this year and last year. We thought we would summarize some of the items discussed.
The Internal Revenue Service (the "IRS") recently issued final regulations governing the diversification requirements for certain ESOPs. As discussed in our February 15, 2008 blog article, the IRS issued proposed regulations under section 401(a)(35) of the Internal Revenue Code (the "Code") in January 2008. The final regulations largely incorporate the proposed regulations with a few changes and clarifications.
For the first time, the IRS is requiring that detailed ESOP distribution rules be provided to the IRS as part of the ESOP's determination letter submission.
In a recent California case, Balsley v. Delta Star Employee Stock Ownership Plan, the U.S. District Court in San Francisco added a little flesh to the bare bones questions of what if any financial disclosure must a company make to ESOP participants in connection with their benefit distributions.
In the first article on this subject that we recently posted, we considered the administrative and fiduciary issues that arise when an ESOP sells company stock to the company to fund its benefit distributions. The fiduciary issues under the Employee Retirement Income Security Act of 1974, as amended ("ERISA") include the need to obtain a new valuation opinion letter from the ESOP's appraiser updated to the date of the sale. This updated opinion letter is required for the sale to be exempt from the prohibited transaction rules of under Section 4975(c)(1)(A) of the Internal Revenue Code of 1986, as amended ("Code") and Section 406(a)(1)(A) of ERISA. In this second article, we consider alternative methods for handling benefit distributions which avoid (or at least reduce) the administrative and fiduciary issues associated with the sale of company stock and the updated valuation opinion. We assume the company's objectives are: (1) to make ESOP distributions in the form of cash in order to avoid having former employees retain stock in the company, (2) to make no additional ESOP contributions to fund this obligation and (3) to preserve stock ownership for ESOP participants who are active employees.
Continue Reading...ESOPs often choose to make benefit distributions in the form of cash, rather than in company stock. Some of these ESOPs obtain the necessary cash by selling company stock to the company. This sale transaction raises two fiduciary issues under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). First, the sale is a prohibited transaction under Section 4975(c)(1)(A) of the Internal Revenue Code of 1986, as amended ("Code"), and Section 406(a)(1)(A) of ERISA, unless the sale meets the exemption in Section 408(e) of ERISA. Second, under Section 404(a)(1) of ERISA, the fiduciary must satisfy itself that the decision to sell company stock is in the best interests of the ESOP's participants.
Continue Reading...The pension plan world is abuzz with last week's U.S. Supreme Court (the "Court") decision in a pension plan case, LaRue v. DeWolff, 552 U.S. ____ (2008). We don't get many decisions by the Supremes in the pension area, so it's worth some focus. We will give just a brief summary of the case (more detailed reviews available all over the Internet) and then focus on the ways the decision might impact ESOPs.
In January 2008, the IRS published proposed regulations ("Proposed Regulations") under the new ESOP diversification rules of Section 401(a)(35) of the Internal Revenue Code ("Code"). The Proposed Regulations could impact several ESOP provisions of the Code, including: the independent appraiser requirement of Section 401(a)(28)(C), the put option rules of Section 409(h)(1)(B), the definition of employer securities under Section 409(l)(1), and the eligibility for a tax deferred sale to an ESOP under Section 1042, all of which apply to employer stock that is not publicly-traded.
Continue Reading...H.R. 3970 introduced by Hon. Charles Rangel on October 25, 2007, includes a Section 3701 that would add Section 409B to the Internal Revenue Code. The new provision would create an additional income tax on the holder of synthetic equity (as defined in Section 409(p)). The new rule would provide that when the holder "exercises" the synthetic equity, in addition to any taxable gain he may recognize from the exercise of the instrument, he must also recognize a new taxable amount. That amount is calculated by determining the amount of S corporation income the holder would have recognized each year, had he held actual stock instead of synthetic equity. In addition, once that amount of additional tax liability is calculated, Section 409B imposes an interest charge on the amount at the underpayment interest rates.
Continue Reading...ESOP Diversification
The January 1, 2007 effective date of the new investment diversification rules for ESOPs with publicly traded stock got us thinking about the diversification rules that extend to companies whose stock is not publicly traded. These rules include some rather difficult timing requirements for most ESOP companies.In December, the IRS published in final form the long-awaited regulations (“Final Regs”) under Internal Revenue Code (“IRC”) Section 409(p). These regulations were first published in proposed form in 2003, and then again as proposed and temporary regulations in 2004. The Final Regs largely follow the 2004 temporary regulations. We thought it would be helpful to discuss the issues the IRS considered in finalizing the regulations and the conclusions reached. In a future ESOP Blog, we will explore some of the difficult and unresolved 409(p) issues that remain in the Final Regs
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