RSM McGladrey ESOP Blog

Workforce Reductions and Partial Plan Terminations

I had a discussion here of this issue back in March (see posts for March 23rd and 24th)

However, the question continues to arise so I thought it was worth visiting this topic again. So here is another summary of the issue - Employers Beware: Workforce Reductions Can Create Retirement Plan Partial Terminations

Are you looking for current conversations on any number of employee ownership topics?

Then please check out this group on LinkedIn – The Employee Stock Ownership Network

The Employee Stock Ownership Network is managed by the National Center for Employee Ownership. The network is an information and networking resource for companies, individuals, consultants and other professionals who work with ESOPs, equity compensation, profit sharing or ownership-related programs. Participants in the network share information, news, and ideas that promote effective use of employee stock ownership plans (ESOPs), restricted stock, stock options, phantom stock, stock appreciation rights, employee stock purchase plans (ESPPs), and worker cooperatives. This is an open networking forum designed to share ideas on best practices, worst practices and more.

Retirement Plan Reform

Yet another consequence of the economic crisis is the focus by policymakers on our current retirement plan system. I know that my 401(k) plan is my primary source of retirement income and it was disconcerting to see such a large portion of my account balance simply disappear.

So my retirement income does not feel as secure to me now as it may have over a year ago. But was it solely a failure of the private retirement plan system or was the failure more of a broad economic failure that no retirement plan system could have avoided?

I am sure that question will be debated. But it does seem possible that the scrutiny on the private retirement plan system may result in legislative changes. 

And we must always remember that the ESOPs and 401(k) plans that your company sponsors are defined contribution retirement plans.  Any changes could impact these existing plans.

This is a pretty good summary of some of the proposals being floated – Defined Contribution Plans:
What Does “Reform” Mean to Employers?

I think the more that we all know about these proposals, the better able we will be to influence the lawmakers as they consider them.   

IRS issues guidance on the suspension of the 3% safe harbor contribution

As many companies cope with these difficult times, they find that they need to eliminate the 401(k) safe harbor contribution. However, while that was possible with the matching form of the safe harbor contribution, it was much more problematic with the 3% safe harbor alternative, until now - IRS Proposes Rules Allowing Employers to Suspend or Reduce Safe Harbor Nonelective Contributions

Top 10 Reasons to Consider Employee Ownership

I had to share this with you in case you didn’t see it – Top 10 Reasons to Consider Employee Ownership

Happy Friday!

Another issue relating to safe harbor contributions made to an ESOP

As I mentioned here earlier this week, there are many requirements applicable to safe harbor 401(k) plans. For example, whether the employer uses the matching or profit sharing contribution approach, all safe harbor contributions must be 100% vested at all times.

In addition, safe harbor contributions generally are not available for hardship withdrawals or other in-service distributions to employees prior to age 59 ½.

An ESOP is required to offer diversification out of company stock for participants who attain age 55 and complete 10 years of participation. Many ESOPs satisfy a participant’s diversification election by making a distribution to that person and that is often an in-service distribution occurring before age 59 ½ .

If the safe harbor contribution is made to the ESOP, it will need to be tracked separately from other contributions. One reason for this separate tracking may be the 100% vesting as it is likely that any other ESOP contributions would not be 100% vested. Another reason is to ensure that there is not a distribution from the safe harbor funds that would violate the prohibition on in-service distributions.

So if an ESOP does satisfy diversification elections via distributions, it may need to make all such diversification distributions from other sources within the ESOP. If that is not possible, then the method of providing diversification may need to be changed from a cash distribution to a transfer to the 401(k) plan. 

Safe Harbor Contributions made to an ESOP

A Safe Harbor 401(k) plan provides a way for employers to avoid nondiscrimination testing by adopting a plan with a guaranteed employer contribution formula.

A Safe Harbor 401(k) plan is exempt from the deferral percentage testing, if the employer commits to provide either a matching contribution of 4% of pay or more for participants who contribute 5% of pay or more to the plan or a profit sharing contribution of 3% of pay or more for all participants, whether they contribute or not (“the contribution requirement”).

There are many requirements applicable to safe harbor 401(k) plans but this type of plan does eliminate much of the uncertainty and complexity associated with designing and administering an employer-sponsored retirement plan with 401(k) features.

So did you know that the safe harbor contribution can actually be made to another qualified plan such as an ESOP?

So what if the safe harbor contribution is made to the ESOP and like other ESOP contributions is applied to the payment of the ESOP’s debt? How is the safe harbor contribution measured – is it the actual cash contributed and then applied to debt payments or is it the fair market value of the shares released on account of such contribution/debt payment?

The IRS was asked this question at the Federal Agency Forum held as a part of The ESOP Association’s Annual Conference last week and their unofficial answer was that it would be the fair market value of the shares released. Of course, they were asked this question during a time frame where it may be more likely that the fair market value of the shares would be less than the cash contribution and that may or may not have influenced the answer.

Of course, like with many issues, there is not 100% agreement on this issue. Many practitioners feel that the safe harbor could be measured by either the cash contributed or the fair value of the shares released and that the plan document should be specific on this point.

Update on Segregation of Former Employees’ ESOP Accounts

As I mentioned here on a couple of occasions, the IRS has been refusing to issue determination letters for ESOPs that contain language that segregates the accounts of former employees out of company stock. And since many practitioners were unwilling to remove this language, these determination letters have been put on hold.  I also mentioned that the IRS was addressing this issue internally in hopes of being able to move forward with the determination letter applications that had been put into their “deep freeze.”

There was a meeting of the various groups within the IRS and some practitioners last week. At The ESOP Association’s annual conference last week, I heard reports from both sides that progress was made at this meeting.

The IRS was also asked about this practice of segregating the accounts of former participants out of company stock at the Federal Agency Forum held as a part of the annual conference. And while the IRS’s responses to these questions can not be considered as official IRS guidance, they do give us an idea of how the individual representatives of the IRS and/or Treasury Department are thinking on these issues.

The response given for whether the accounts of former participants could be segregated was that this should be acceptable as long as the nondiscrimination requirements of Code Section 401(a)(4) are satisfied and the practice does not constitute indirect, forced cash out distributions.  Since former employees are tested separately from active employees, the nondiscrimination requirements should be satisfied as long as all former employees are treated the same. A nondiscrimination issue could arise if you attempted to treat one group of former employees differently than others.  Also, a nondiscrimination issue could arise if the practice is changed at some point in the future. The obvious example would be if the practice is changed at some point in the future because a highly compensated employee does not want his or her company stock account to be converted into other investments.  But many companies may be facing cash flow shortages and may have to change this policy since there is not enough cash to fully segregate all of the accounts. Such change would need to be reviewed to ensure it is not discriminatory.

So while these comments do not constitute official guidance, it seems that there is hope that the IRS will start issuing determination letters for ESOPs that contain this language. And here is my standard caveat – you should consult with your own ESOP advisors to design a segregation policy that would meet all of the requirements of the Internal Revenue Code.

It is time for my annual trip to Washington, DC

I will be attending The ESOP Association’s 31st Annual Conference. I am not entirely sure but I believe this will be my 16th trip to this conference.

But somehow this trip seems like it may be more important somehow for a variety of reasons.

Of course, the fact that there is a new Administration with significantly different policies than what we have seen recently means that they could certainly intend to make legislative changes that make impact ESOP companies in the future. Add in the economic crisis and its impact on 401(k) and pension plans and perhaps we should not be surprised to see proposed changes impacting all retirement plans, including ESOPs. Or perhaps legislation impacting ESOPs could be enacted as a part of corporate tax reform.

And what about the Chrysler situation and the proposed “employee ownership” –

Chrysler and Employee Ownership?

At Chrysler and GM, It's Not Employee Ownership

Finally, there are all of the uncertain technical issues relating to ESOPs. A great part of this conference is the chance to hear the IRS comment (albeit unofficially) on these issues. It seems like there are a whole new category of these issues that are stemming from the economic crisis.

So I am off once again and will report back here on these and any other issues discussed this week. 

 

Diamonds in the Ashes: Opportunities for ESOP Companies in the Current Recession

This looks like an excellent online seminar so I thought I would share it with you -Diamonds in the Ashes: Opportunities for ESOP Companies in the Current Recession

Happy Friday and May Day all in one!