ESOP Lawyer & Attorney : Sheppard Mullin Law Firm : Employee Stock Ownership Plans : ESOP Law Blog

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.

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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.

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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.

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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.

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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.

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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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We are pleased to announce that Sheppard Mullin and Larry Goldberg  have launched a new blog on Employee Stock Ownership Plans (ESOPs). You can access it at http://www.esoplawblog.com.  A blog is an online web journal. You will now be able to access up-to-date information on  ESOP Law.

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While you may have already seen general descriptions of the PPA, this ESOP Blog focuses on the PPA provisions that relate to ESOPs, and provides some planning considerations for ESOP companies. 

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