ESOP Planning 2008: Distributions (1 of 4)

Distribution planning is one of the most important components of the planning process. Even if you had a detailed plan in place when you established your plan, chances are that things have changed. You should perform a distribution analysis annually. Here are some things to consider:

• Will you be required to make payments to participants in the next year? – Here are the rules for determining when you must begin offering participants an opportunity to request a distribution:
  
  
  • Death, Disability, Retirement – IRC Section 409(o)(1)(A)(i) - Qualifications for tax credit employee stock ownership plans - Distribution and payment requirements – Distribution requirement – In general requires that payments to participants that terminate as a result of death, disability, and retirement (as defined by the plan) begin within one year after the end of the plan year of the termination. For example (assuming a 12/31 plan year end), if a participant terminates after meeting the retirement provisions of the plan on June 29, 2007, the participant must be paid out after the December 31, 2007 allocation is completed (which should be sometime in 2008), and the payment must be made by December 31, 2008.
    
    
  • Other Termination of Service – For other separations of service, IRC Section 409(o)(1)(A)(ii) - Qualifications for tax credit employee stock ownership plans - Distribution and payment requirements – Distribution requirement – In general requires payment one year after the end of the fifth plan year after the year of termination. For example (assuming a 12/31 plan year end), if a participant terminates on June 29, 2007, the participant must be paid out after the December 31, 2012 allocation is completed, and the payment must be made by December 31, 2013.
    
    
  • Loan Exception – If there is an outstanding ESOP loan, IRC Section 409(o)(1)(B) - Qualifications for tax credit employee stock ownership plans - Distribution and payment requirements – Distribution requirement – Exception for certain financed securities allows payments to participants terminating for reasons other than death, disability, or retirement to be deferred until the close of the plan year in which the loan is paid in full. [If you are an S Corporation, there is some controversy about the loan exceptions because the language specifically references a C Corporation loan. Despite this technicality, many S Corporation ESOPs utilize the loan exception. To gain more comfort, the loan exception could be drafted in the plan document to receive a determination letter on the provision.]
    
    
• What distribution provisions are in your plan document? Are they more liberal than the above-mentioned statutory requirements? – In many cases the distribution provisions provided in the plan document will mirror the Code's requirements, but you should review your plan document to see if there are any additional distribution provisions in your document and treat those provisions as the minimum. You should also identify if there are any other distribution requirements. Examples include in-service withdrawals, early retirement distributions, and non-statutory diversification distributions (which are generally treated as in-service withdrawals and not diversification distributions).
  
  
• Do you have a written distribution policy? – If not, do you have an informal distribution policy that is not in writing? It is strongly recommended to have a written distribution policy and review it regularly. Some plans prepare a distribution policy every year. This is one of the most important items of the planning process. I strongly recommend that you do not delay your Repurchase Obligation and Distribution Planning.

The second installment of ESOP Planning 2008: Distributions will discuss the following questions:

• What is your distribution policy?
• Are you aware of your future repurchase obligation?
• How will the company provide funding for the future repurchase obligation?

The ESOP Planning process includes planning for both the current year ESOP administration process as well as the various events that take place over the life of an ESOP. This article is one in a series of ESOP Planning 2008 articles authored by Aaron Juckett. Aaron Juckett is an ESOP consultant and the founder of ESOP Insourcing LLC, an ESOP administration and consulting firm dedicated to providing ESOP companies with a first-class ESOP experience. If you need assistance with the ESOP Planning process, please call Aaron at 800-837-3112 or email him at ajuckett@esopinsourcing.com.

Revisiting the LaRue Takeaways

I am sure everyone remembers the discussions following the LaRue ruling in February. Just in case you missed it, let's take some time to review some of the recommended takeaways and best practices:

• Documentation and Due Diligence – Ensure best practices of documentation and due diligence are taking place for all fiduciary decisions to demonstrate that decisions are being made with the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan.
  
  
  • Plan Expenses – Review the Plan Expenses to ensure that fees charged by service providers, attorneys, valuation firms, etc. are reasonable.
    
    
  • Service Agreements – Review service agreements to ensure the allocation of liability and indemnification rights between the plan sponsor and service providers is clear.
    
    
• Compliance with ERISA Section 404(c) – Review Plan Documents and Disclosures, administration policies and procedures, and quality control processes to ensure full compliance with ERISA Section 404(c).
  
  
  • Administrative Policies and Procedures – Make sure that the possibility of administrative errors is minimized and that participant directions are promptly processed and implemented. Make changes to the plan document, SPD, and administrative forms and processes as needed.
    
    
  • Investment Policies and Procedures – Review investment policies and procedures to make sure that the investment options are prudent. Consider providing access to investment advisors when appropriate.
    
    
• Claims Procedures – Treat challenges to plan administration and investment errors as claims for benefits under the plan. Denial of benefit claims under ERISA Section 502(a)(1)(B) require the participant to first exhaust administrative remedies and give the plan the opportunity to review the claim and either grant the claim or potentially put the plan in a better position to defend itself if the claim is denied and later litigated.
  
  
• Fiduciary Liability Insurance and Training – Make sure you have adequate Fiduciary Liability Insurance for all plan fiduciaries and that the coverage is non-wasting. Provide training to fiduciaries on an ongoing basis about their fiduciary exposure and ways to minimize their risk.
  

For more information on the case itself, check out the LaRue v. DeWolff, Boberg & Assoc. Inc., No. 06-856 (Feb. 20, 2008) information page and related links.

ESOP Planning 2008: Plan Expenses

Most 401(k) plan sponsors have become accustomed to performing a due diligence review of plan expenses every one to five years. This review is done primarily because ERISA provides that qualified retirement plans are solely for the benefit of the participants and that plan expenses must be reasonable. The review also helps ensure that fees as well as the supplementary tools provided are competitive with the marketplace.

Since expenses for most ESOPs are paid outside of the plan, fees are typically not reviewed as closely. However, a due diligence review would still be beneficial. Are the fees that you are paying reasonable? Are they competitive in the marketplace? While it is important to have competent ESOP advisors who you trust, does the cost of using the advisors exceed the benefits that you are receiving? A thorough analysis, which may or may not include obtaining proposals from other firms, could result in lower fees or more included services, and you may not even have to switch advisors to obtain this adjustment.

It is also important to make sure that you are comparing apples to apples. I am sure you have heard that cliché before, but it is definitely relevant with plan expenses. Some advisors charge one fee for all the services you will need, while others charge for each service separately. When you are comparing the overall cost, it is important to make sure you are using the total cost for a particular time period (usually one year). To make things easier for your due diligence review, you should request that all advisors provide you with a specific and detailed estimate of what the total expenses would be for one year.

Some advisors will also bundle into their fees services you do not need or can easily process in-house. You should not hesitate to request a separate quote based on removing functions that you do not need or could process in-house. You may discover that you can significantly reduce your overall fees (and may even improve your advisor's profitability, a win-win for both parties). At a minimum, you will get a good idea of the flexibility of the advisor.

Another thing advisors may offer is a reduced fee for bundling services, only to build the fees into your 401(k) or other plan expenses. While this may seem attractive and reduce the company's direct expenses, it may not be in the interests of your 401(k) participants and could be a breach of your fiduciary responsibilities.

In addition to price, here are some other factors to consider:

• Quality of service (How often are mistakes made, how are mistakes handled?)
• Timeliness of service (Do you get your deliverables when you want them? How persistent do you need to be to get your deliverables on time?)
• Technology (Do you get reports, statements, and other information in the form and format that you desire?)
• The advisor's background and experience with ESOPs of similar size and complexity
• Your relationship with the advisor (Sometimes you cannot put a price tag on trust.)
  

You should employ this process in reviewing all of your ESOP expenses, including your ESOP recordkeeping and administration, consulting, legal, fiduciary, valuation, and audit expenses. In addition to the potential cost benefits, a DOL Auditor stated that they focus on your selection process for choosing a valuation firm, providing another reason for performing a due diligence review of all of your ESOP advisors on a regular basis.

The ESOP Planning process includes planning for both the current year ESOP administration process as well as the various events that take place over the life of an ESOP. This article is one in a series of ESOP Planning 2008 articles authored by Aaron Juckett. Aaron Juckett is an ESOP consultant and the founder of ESOP Insourcing LLC, an ESOP administration and consulting firm dedicated to providing ESOP companies with a first-class ESOP experience. If you need assistance with the ESOP Planning process, please call Aaron at 800-837-3112 or email him at ajuckett@esopinsourcing.com.

In re Ford Motor Co. ERISA Litigation, No. 06-11718

Federal Judge Allows Ford ESOP Suit to Move Forward discusses how In re Ford Motor Co. ERISA Litigation, No. 06-11718 (E.D. Mich. December 22, 2008) modified In re Ford Motor Co. ERISA Litigation, No. 06-11718 (E.D. Mich. March 31, 2008) and denied the defendants' motion to dismiss the case on grounds that they committed no fiduciary breach under ERISA because the plan is required to be invested in company stock:

However, U.S. District Judge Stephen J. Murphy, III noted in his opinion that while ERISA does provide an exemption from diversification rules for ESOPs, it does so while still requiring that the plan sponsor act with prudence when investing in company stock.

Using previous case history Ford argued that it did not commit a fiduciary breach by continuing to invest in Ford stock because, during the class period, it was not facing "imminent collapse." Also looking to prior case history and the statutory language of ERISA, Murphy rejected this argument, saying that the "presumption of prudence means that [the law] requires fiduciaries to divest their plans of company stock when holding it becomes so risky - that is, so imprudent - that the problem could not be fixed by diversifying into other assets."

Finally, Ford argued that a magistrate judge that refused to dismiss the case previously erred by not considering the ESOPs company stock investments together with other investments in other retirement plans offered to employees. Ford said that because its employees were free to diversity their retirement savings across all plans offered to them, they were greatly exaggerating the risk the stock plans presented to their retirement savings.

Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act)

Last week we discussed the importance of making sure your plan been amended for changes in legislation in ESOP Planning 2008: Plan Documents and Disclosures. One of the major pieces of Employee Benefits Legislation enacted in 2008 is the HEART Act. Some of the changes were retroactive to 2007 and others are effective January 1, 2009, so you will need to make sure you are complying with the new regulations, determine if any retroactive adjustments need to be made, and ensure that the rules are properly applied going forward. An amendment must be adopted by the end of the 2010 plan year.

The Heroes Earnings Assistance and Relief Tax Act of 2008 (HEART Act) was signed into law on June 17, 2008 to provide benefits for military personnel. The HEART Act includes qualified plan provisions, including the following:

• Additional Benefits For Death or Disability During Military Service –The Heart Act added IRC Section 401(a)(37) to the Internal Revenue Code to provide benefits to participants who die while performing qualified military service as if they had resumed and then terminated employment on the date of death:

  "§401(a)(37) DEATH BENEFITS UNDER USERRA-QUALIFIED ACTIVE MILITARY SERVICE.
  
  A trust shall not constitute a qualified trust unless the plan provides that, in the case of a participant who dies while performing qualified military service (as defined in section 414(u)), the survivors of the participant are entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) provided under the plan had the participant resumed and then terminated employment on account of death.''

• Permanent Ability to Take Distributions Without Being Subject to the Early Withdrawal Penalty – The HEART Act makes permanent the ability to take distributions without being subject to the IRC Section 72(t) - 10-percent additional tax on early distributions from qualified retirement plans early withdrawal penalty.
  
  
• Ability to Re-Contribute Distributions to an IRA on an After-Tax Basis
  
  
• Differential Pay is Treated as Wages and Reported on the Employee's W-2
  
  
• Military Death Benefits Can be Rolled to a Roth IRA
  
  
• A Deemed Sale is Imposed Upon Expatriation

For more information, here is a summary.

Fiduciary Liability Insurance

We noted in our recent ERISA Fidelity Bonding discussion that fiduciary liability insurance does not satisfy the fidelity bonding requirements. This was reiterated in Field Assistance Bulletin No. 2008-04 – EBSA issues guidance on fidelity bonding for employee benefit plans. FIDUCIARY LIABILITY INSURANCE: A Risk Management Tool for Fiduciaries in a New Retirement Plan Environment discusses what fiduciary liability insurance provides:

This coverage protects plan sponsors and trustees from the defense and penalties if they are sued for fiduciary decisions they make for an employee benefit plan. Plan fiduciaries are open to many types of lawsuits. Plan participants may sue individually or as a class if they feel that benefits were misrepresented or if they believe that different decisions by the trustees could have yielded a higher return. They may even sue over enrollment issues.

ERISA Section 410, 29 U.S.C. Section 1110 - Exculpatory provisions; insurance provides that while a company cannot relieve a fiduciary of their fiduciary responsibilities or liabilities, the company or the fiduciary can purchase fiduciary liability insurance:

(a) Except as provided in sections 1105(b)(1) and 1105(d) of this title, any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty under this part shall be void as against public policy.

(b) Nothing in this subpart ^[1] shall preclude—

(1) a plan from purchasing insurance for its fiduciaries or for itself to cover liability or losses occurring by reason of the act or omission of a fiduciary, if such insurance permits recourse by the insurer against the fiduciary in the case of a breach of a fiduciary obligation by such fiduciary;

(2) a fiduciary from purchasing insurance to cover liability under this part from and for his own account; or

(3) an employer or an employee organization from purchasing insurance to cover potential liability of one or more persons who serve in a fiduciary capacity with regard to an employee benefit plan.

It also explores the potential impact of LaRue v. DeWolff, Boberg & Assoc. Inc., No. 06-856 (Feb. 20, 2008) on fiduciary liability and answers the following questions:

• Is Fiduciary Liability Insurance mandatory under ERISA?
• Doesn't the ERISA/Fidelity Bond cover lawsuit costs?
• Who can file a lawsuit against a fiduciary?
• What does fiduciary liability insurance generally cover?
• What parties are normally covered by the policy?
• What are typical defense costs in a fiduciary lawsuit?

H.R. 7327: Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) / Required Minimum Distributions (RMDs)

The Worker, Retiree, and Employer Recovery Act of 2008 (WRERA)

H.R. 7327: Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) has been passed by both chambers of Congress and was signed yesterday by the President. The bill, with the purpose of making technical corrections related to the Pension Protection Act of 2006 (PPA), and for other purposes, will become law once administrative actions are complete. Congress Passes Emergency Pension Tax Relief/Technical Corrections highlights the major provisions:

• Relief for retirees from RMDs from qualified plans and IRAs
• Relief for employers from asset depreciation by clarifying permitted use of smoothing over 24 months for pension plan funding
• Relief from funding transition rules by eliminating 100-percent funding for failures
• Relief for multi-employer plans, by allowing sponsors to elect to temporarily freeze at funding status held in previous plan year
• Relief from mandatory accrual of pension benefits
• Increases in failure-to-file penalty fees for partnerships and S corps

WRERA Impact on 2009 RMDs

One of the major provisions of the WRERA is to provide a waiver of the requirement to take RMDs in 2009. Required Minimum Distribution Relief for 2009 Clarified provides additional analysis.

WRERA Impact on 2008 RMDs

While the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) will provide protection for 2009 RMDs, it appears that it will not provide protection for 2008 RMDs. BenefitsLink has obtained a copy of a letter, date stamped December 17, 2008, from Kevin I. Fromer, Assistant Secretary for Legislative Affairs, to Representative George Miller [D].

This letter follows up on our previous response to your letter regarding required minimum distributions from individual retirement arrangements (IRAs) and 401(k) plans in light of the recent financial downturn. In my letter, I noted that efforts had begun in Congress to provide temporary relief from the minimum distribution requirement and, at the same time, the Treasury Department and the Internal Revenue Service were considering ways this unanticipated situation could be ameliorated administratively. Since that time, Congress enacted the Worker, Retiree, and Employer Recovery Act of 2008 providing extensive relief to IRA holders and plan participants regarding required minimum distributions. The President is expected to sign this legislation in the near future.

After consulting with the Office of Tax Policy, I wanted to inform you that, because Congress has provided broad and direct relief with respect to this issue, the Treasury Department and the Internal Revenue Service have determined that any further change to the required minimum distribution rules should not be undertaken. The scope of Treasury's ability to make administrative changes has constraints. Thus, any steps Treasury could take would be substantially more limited than the relief enacted by Congress and could not be made available uniformly to all individuals subject to required minimum distributions. In addition, implementation of such changes would be complicated and confusing for individuals and plan sponsors. Thus, all individuals who are subject to required minimum distributions for 2008 should take their distribution under the existing rules and, as a result of relief provided by Congress, they will be entitled to a complete waiver of the requirement to take any distributions for 2009.

Thank you for your letter and concern about this important matter.

What are Required Minimum Distributions?

IRC Section 401(a)(9) - Qualified pension, profit-sharing, and stock bonus plans - Required distributions provides statutory guidance on RMDs. An IRS Retirement Plans FAQs regarding the Required Minimum Distributions also provides a definition:

Required Minimum Distributions (RMDs) generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires. However, if the retirement plan account is an IRA or the account owner is a 5% owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 70 ½, regardless of whether he or she is retired.

Retirement plan participants and IRA owners are responsible for taking the correct amount of RMDs on time every year from their accounts, and they face stiff penalties for failure to take RMDs.

When a retirement plan account owner or IRA owner dies before RMDs have begun, different RMD rules apply to the beneficiary of the account or IRA. Generally, the entire amount of the owner's benefit must be distributed to the beneficiary who is an individual either (1) within 5 years of the owner's death, or (2) over the life of the beneficiary starting no later than one year following the owner's death. See Publication 590 - Individual Retirement Arrangements (IRAs) for complete details on when beneficiaries must start receiving RMDs.

The IRS RMD information page also answers the following questions

1. What types of retirement plans require minimum distributions?
2. When is the deadline for receiving a RMD from an IRA?
3. How is the amount of the RMD calculated?
4. Can an account owner just take a RMD from one account instead of separately from each account?
5. Who calculates the amount of the RMD?
6. Can an account owner withdraw more than the RMD?
7. What happens if a person does not take a RMD by the required deadline?
8. Can the penalty for not taking the full RMD be waived?
9. Can a distribution in excess of the RMD for one year be applied to the RMD for a future year?
10. How are RMDs taxed?
11. Can RMD amounts be rolled over into another tax-deferred account?

Required Beginning Date

Generally, all participants must receive their first RMD by the April 1 of the year following the year they meet both of the following requirements: attain age 70½ and terminate employment. This date is referred to as the participant's required beginning date.

Here is an example of a participant that met both requirements in 2007:

• Required Beginning Date – Since the participant met both requirements in 2007, the required beginning date is April 1, 2008.
• RMD #1 - The participant must receive their first RMD by April 1, 2008. This RMD is the participant's 2007 RMD and is calculated using the 2006 balance.
• RMD #2 - The participant must receive their second RMD by December 31, 2008. This RMD is the participant's 2008 RMD and is calculated using the 2007 balance.
• Each subsequent RMD - Each subsequent RMD will be due on each subsequent December 31 (calculated using the prior year's balance).

Some plans provide eligible participants with the option to take their first RMD in the year they satisfy both requirements. Using the example, the participant would take their first RMD in 2007.

Another option is for the participant to take both their first and second RMDs before April 1 of the year the RMDs are due. Using the example, the first two RMDs would be taken in 2008 by April 1, 2008.

RMD Calculators

Here are two online RMD calculators you may find useful.

1. Required Minimum Distribution Calculator – This calculator requires you to enter the age as of December 31, 2008, and the balance as of December 31, 2007. This calculator will not handle the scenario of a spouse beneficiary that is more than ten years younger than the participant, as this scenario requires the usage of the Joint Expectancy tables.
   
2. Financial Calculators – Required Minimum Distribution (RMD) – This calculator has more factors to input and is able to handle the beneficiary scenario discussed above. The calculator will also estimate future RMDs and account balances based on the future estimated rate of return.

I previously tested the calculators using this Uniform Lifetime Table and my calculation agreed with the online calculators.

ESOP Cash

While we will be discussing distributions in an upcoming ESOP Planning 2008 installment, one relevant topic we will be discussing is if the ESOP will have enough cash to satisfy the RMD requirements:

Do you have enough cash in the ESOP to pay RMDs? Another factor to consider for RMDs is that the plan may not have enough cash to pay to the participant(s) to satisfy the RMD requirements. If this is the case, the plan will most likely have three options:

• The stock will be repurchased (recycled) in the plan to other participants - cash will need to be contributed to the plan.
  
• The stock will be sold and the proceeds used to pay the participants – a stock appraisal on the date of the sale will need to be obtained.
  
• The stock will be distributed and put back to the company (or the ESOP). It is important to note that as it gets closer to December 31, it becomes more likely that the stock value may be "stale" (see above discussion) and not an accurate reflection of the actual stock value.

This situation can be avoided if you have identified RMDs ahead of time and have a well-planned distribution policy.

What value should be used to determine the number of shares to distribute?

The value of the distribution is calculated using the fair market value of the stock as of the date of the distribution, and the value of the distribution must be at least equal to the amount required to be distributed to satisfy the RMD requirements. RMDs – How many shares to distribute? discusses an example.

ESOP Planning 2008: Plan Documents and Disclosures

One of your most important responsibilities is to ensure that your plan documents are updated as required by law and are consistent with the way the plan is actually being administered. Plan documents include, but are not limited to, the plan document, trust document, summary plan description (SPD), and loan documents. While your review of the plan documents should be an ongoing process, you generally need to make sure that any amendments or restatements are executed by the last day of the plan year if you intend for them to be effective for that plan year. You should start by answering the following questions and using your answers as a starting point to a discussion with your ESOP counsel and ESOP advisor:

• Are all your plan documents consistent? Do your plan document and SPD provide for consistent plan provisions? For example, does your SPD provide for different eligibility provisions than your plan document? Now is a good time to work with your ESOP consultant or counsel to resolve any Conflicts Between the Plan Document and the Summary Plan Description (SPD), because Courts Will Not Always Enforce Plan Document Provisions If They Differ From SPD. In fact, SPD Language Providing Less Plan Benefits can sometimes overrule the Plan Document Language.
  
  
• Are your plan documents consistent with how the plan is being administered? You need to discuss any inconsistencies with your ESOP consultant or counsel.
  
  
• Have you received any amendment recommendations from your advisors that have not been addressed? An example would be a recommendation made during the allocation process to amend the plan to improve the compliance testing results in future years. If recommendations have been made, this review is a good opportunity to revisit the recommendations and determine whether or not they are going to be made (assuming you have not already made them). If you are not going to make the changes, it is a good idea to discuss the reasons with the party who made the recommendations and ensure that everyone is on the same page.
  
  
• Do you have signed copies of your plan documents and amendments? Are they organized and easily accessible? If not, now is a good time to work with your ESOP counsel and other advisors to organize a complete set of signed plan documents. Make sure all your advisors also have a complete set of the plan documents to ensure that the plan is being administered consistently and correctly. This is also a good time to revisit your records retention procedures to make sure you will easily be able to obtain a backup copy of the plan documents, if needed.
  
  
• Do any of your documents need to be updated or restated? ERISA requires that you update the Summary Plan Description (SPD) every 10 years, assuming there are no plan changes. Most likely, your plan will have made some changes and you will need to update it every five years. In addition, you must provide a Summary of Material Modifications (SMM) "no later than 210 days after the close of the plan year in which the modification or change was adopted." The SPD and SMM requirements are examples of What a DOL Auditor is Looking For When Auditing an ESOP.
  
  Also, remember that a recent court case found that posting the SPD on an Intranet was not sufficient to ensure a participant received it, and that failing to ensure receipt can have a bearing on the Standard of Review.
  
  
• Are there plan provisions that are not documented that should be? Examples include a distribution policy and how your plan handles the reallocation of repurchased shares.
  
  
• What plan disclosures are required to be delivered to participants between now and your next plan documents review? Examples include the above-mentioned SPD and the annual Safe Harbor Notice. If you have any intentions of Reducing or Eliminating Safe Harbor Matching Contributions during the plan year, you should make sure you are familiar with the requirements.
  
  
• Has your plan been amended for changes in legislation? Since an ESOP plan document is individually designed, it is your responsibility to ensure that the plan document is updated for legislative changes. There have many changes in Employee Benefits Legislation since ERISA. The Pension Protection Act of 2006 (PPA) was signed into law on August 17, 2006, and according to some experts, contains the most comprehensive reforms since ERISA was enacted in 1974. Here are some of the major changes provided by the PPA that are related to ESOPs:
  
  
  • Made the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) permanent (more favorable contribution limits, improved portability of retirement accounts, etc.)
    
    
  • Accelerated vesting requirements to at least a three-year cliff or six-year graded vesting schedule (There is an exception for ESOPs with a loan outstanding.)
    
    
  • Increased the ERISA Fidelity Bonding maximum from $500,000 to $1,000,000 for most plans with employer securities.
    
    
  • Added regulations requiring additional diversification requirements for public ESOPs. The definition of publicly traded in the IRC Section 401(a)(35) Proposed Regulations has an impact on many ESOP provisions including IRC Section 401(a)(28)(C) - Use of independent appraiser, IRC Section 409(h)(1)(B) - Right to demand employer securities; put option, IRC Section 409(l)(1) - Employer securities defined, and IRC Section 1042(c)(1) - Sales of stock to employee stock ownership plans or certain cooperatives - Qualified securities. The regulations also create some challenges for thinly traded ESOP companies and ensuring that the ESOP receives adequate consideration.
    
    
  • Created a requirement to provide Participant Benefit Statements to participants on an annual basis (or quarterly when assets are self-directed).
    
    
  • Added a Qualified Automatic Contribution Arrangement (QACA), which is another 401(k) safe harbor option that allows contributions to be fully vested in two years (which may be more desirable than the existing safe harbor options that require immediate vesting).
    

  There were many additional changes and opportunities provided by the PPA. The ESOP Law Blog addresses six of the ESOP-related PPA provisions. PPA amendments are generally not due until the last day of the 2009 plan year. The PPA does not distinguish between required and discretionary amendments.
  

  The Summary of Employee Benefits Legislation since ERISA lists the following legislation since the PPA:
  
  

  • Michelle's Law 2008
  • Emergency Economic Stabilization Act of 2008
  • ADA Amendments Act of 2008
  • Heroes Earnings Assistance and Relief Tax Act of 2008
  • Genetic Information Nondiscrimination Act of 2008
  • National Defense Authorization Act for Fiscal Year 2008

  2008 End of Year Checklist and More Year End Checklists provide links to checklists of items for the plan sponsor to address by the end of 2008. Post-Gust Required Amendments contains a list of required amendments and due dates for defined contribution plans since the GUST restatement. If you have a different plan year, some of the due dates will be different.
  
  There may be other requirements and desirable opportunities from prior legislation that should be added to your plan documents. Contact your ESOP consultant or counsel for more information.

The ESOP Planning process includes planning for both the current year ESOP administration process as well as the various events that take place over the life of an ESOP. This article is one in a series of ESOP Planning 2008 articles authored by Aaron Juckett. Aaron Juckett is an ESOP consultant and the founder of ESOP Insourcing LLC, an ESOP administration and consulting firm dedicated to providing ESOP companies with a first-class ESOP experience. If you need assistance with the ESOP Planning process, please call Aaron at 800-837-3112 or email him at ajuckett@esopinsourcing.com.

Summary of Employee Benefits Legislation since ERISA

Chronological Summary of Major Post-ERISA Benefit Legislation provides a summary of the major employee benefits legislation since ERISA:

• Michelle's Law 2008
• Emergency Economic Stabilization Act of 2008
• ADA Amendments Act of 2008
• Heroes Earnings Assistance and Relief Tax Act of 2008
• Genetic Information Nondiscrimination Act of 2008
• National Defense Authorization Act for Fiscal Year 2008
• Pension Protection Act of 2006
• Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
• Veterans Benefits Improvement Act of 2004
• American Jobs Creation Act of 2004
• Working Families Tax Relief Act of 2004
• Extension of Current Mental Health Parity – 2004
• Pension Funding Equity Act of 2004
• Mental Health Parity Reauthorization Act of 2003
• Medicare Prescription Drug, Improvement, and Modernization Act of 2003
• Jobs and Growth Tax Relief Reconciliation Act 2002
• Sarbanes-Oxley Act of 2002
• Trade Adjustment Assistance Reforms – 2002
• The Public Health Security and Bioterrorism Preparedness and Response Act of 2002
• Job Creation and Worker Assistance Act of 2002
• Victims of Terrorism Tax Relief Act of 2001
• Administrative Simplification Compliance Act of 2001
• Economic Growth and Tax Relief Reconciliation Act of 2001
• Ticket to Work and Work Incentives Improvement Act of 1999
• Omnibus Consolidated and Emergency Supplemental Appropriations Act of 1998
• Higher Education Amendments Act of 1998
• Internal Revenue Service Restructuring and Reform Act of 1998
• Savings Are Vital to Everyone's Retirement (SAVER) Act of 1997
• Balanced Budget Act of 1997
• Taxpayer Relief Act of 1997
• Defense of Marriage Act of 1997
• Medicare and Medicaid Coverage Data Bank Repeal Act of 1996
• Mental Health Parity Act of 1996
• Newborns' and Mothers' Health Protection Act of 1996
• Personal Responsibility and Work Opportunity Reconciliation Act of 1996
• Health Insurance Portability and Accountability Act of 1996
• Small Business Job Protection Act of 1996
• Taxpayer Bill of Rights 2 of 1996
• Contract With America Advancement Act of 1996
• "State Source Tax" Prohibition
• Defense Appropriations
• Uruguay Round of General Agreement on Tariffs and Trade (Retirement Protection Act of 1994)
• Uniform Services Employment and Reemployment Rights Act of 1994
• Defense Appropriations
• Omnibus Budget Reconciliation Act of 1993
• Family and Medical Leave Act of 1993
• Comprehensive National Energy Policy Act of 1992
• Unemployment Compensation Amendments of 1992
• Civil Rights Act of 1991
• Omnibus Budget Reconciliation Act of 1990
• Older Workers Benefit Protection Act
• Americans With Disabilities Act of 1990
• Medicare Catastrophic Coverage Act Repeal (Repealed in 1989)
• Omnibus Budget Reconciliation Act of 1989
• Section 89 repeal
• Technical and Miscellaneous Revenue Act of 1988
• Health Maintenance Organization Act Amendments of 1988
• Family Support Act of 1988
• Medicare Catastrophic Coverage Act of 1988
• Pension Protection Act of 1987
• Age Discrimination in Employment Act Amendments
• Omnibus Budget Reconciliation Act of 1986
• Tax Reform Act of 1986
• Consolidated Omnibus Budget Reconciliation Act of 1986
• Retirement Equity Act of 1984
• Deficit Reduction Act of 1984
• Social Security Amendments of 1983
• Tax Equity and Fiscal Responsibility Act of 1982
• Economic Recovery Tax Act of 1981
• Revenue Act of 1980
• Multiemployer Pension Plan Amendments Act of 1980
• Pregnancy Discrimination Act of 1978
• Revenue Act of 1978
• Age Discrimination in Employment Act of 1978
• Social Security Amendments of 1977
• Tax Reform Act of 1976
• Tax Reduction Act of 1975
• Employee Retirement Income Security Act of 1974 (ERISA)

Chapter 11 Success Stories/Pension and Cash Balance Plans Protected by ERISA and Insured by the PBGC

With all of the recent stories about the Bankruptcy Filings of companies such as the Tribune Company, I am often asked about what will happen to the retirement benefits of the participants. Here are some items to consider:

• Is the Bankruptcy Filing a Chapter 11 Reorganization or a Chapter 7 Liquidation? When many people think of bankruptcy, they automatically think of a Chapter 7 liquidation. In a Chapter 11 Reorganization, the company will generally continue to exist. Companies that are considered to be Chapter 11 success stories include Texaco, Continental Airlines, Southland Company (7-Eleven), Macy's, and Toys-R-Us.
  
  
• Pension benefits are protected in bankruptcy by the Employee Retirement Income Security Act of 1974 (ERISA). The Department of Labor (DOL) has a guide that provides additional information about how a bankruptcy will affect your benefits: Fact Sheet: Your Employer's Bankruptcy - How Will It Affect Your Employee Benefits?
  
  Workers in bankruptcy situations face two important issues when it comes to their retirement benefits: access to pension benefits and the continued safety of their pension assets. Generally, your pension assets should not be at risk when a business declares bankruptcy, because ERISA requires that promised pension benefits be adequately funded and that pension monies be kept separate from an employer's business assets and held in trust or invested in an insurance contract. Thus, if an employer declares bankruptcy, the retirement funds should be secure from the company's creditors. In addition, plan fiduciaries must comply with the ERISA provisions that prohibit the mismanagement and abuse of plan assets. If contributions to a plan have been withheld from your pay, you may want to confirm that the amounts deducted have been forwarded to the plan's trust or insurance contract.
  
  
• The Fact Sheet also discusses how insurance for defined benefit plans (including pension and cash balance plans) is provided by the Pension Benefit Guaranty Corporation.
  

  In addition, some pension benefits may be insured by the Federal Government. Traditional plans (defined benefit plans) are protected by the Pension Benefit Guaranty Corporation (PBGC), a Federal Government corporation. If a plan is terminated because an employer has financial difficulty and cannot fund the plan, and the plan does not have enough money to pay the promised benefits, the PBGC will assume responsibility for the plan. The PBGC pays benefits after termination up to a certain maximum guaranteed amount. On the other hand, defined contribution plans, such as 401(k) plans, are not insured by the PBGC.
  

More Year End Checklists

Yesterday I shared a 2008 End of Year Checklist. Here are links to two other checklists. I will share further analysis in subsequent posts, including the next ESOP Planning 2008 installment: ESOP Planning 2008: Plan Documents and Disclosures

2008 Year-End Retirement Plan Checklist provides a checklist of potential year-end items to review:

• Annual Notice Requirements
  
  • Safe-Harbor 401k Annual Plan Notice
    
  • Qualified Default Investment Alternative ("QDIA") Notice
    
  • 401k Plan Annual Automatic Enrollment Notice
    
  • Defined Benefit Pension Plan Annual Funding Notice
    
  • Participant Benefit Statements
    
• Plan Amendments
  
  • Discretionary Changes
    
  • Code Section 415 Amendments
    
  • Pension Funding Equity Act Amendments for Defined Benefit Plans
    
• Required Minimum Distributions
  
  • Owners
    
  • Non-owners
    
  • Beneficiaries
    
• IRS Determination Letter Program
  
• Written Plan Document Deadline for Code Section 403(b) Plans
  

Year-End Checklist for Benefit Plan Sponsors provides checklists for retirement plans and deferred compensation:

Retirement Plans

• Execute by 12/31/08 all required plan amendments and documents
• Distribute required notices (as applicable)
• Decide on plan design choices for 2008 - 2009
• Implement operational changes for 2008 - 2009
• Monitor investment performance and make changes, as appropriate, in compliance with fiduciary duties
• Evaluate disclosure of plan fees, expenses and investment-related information for reasonableness, subject to coordination with plan administrator and service providers

Deferred Compensation

• Review and amend by 12/31/08 all plans, contracts or arrangements providing for any type of nonqualified deferred compensation, so that they meet the final rules under Internal Revenue Code Section 409A
• Implement list of "specified employees" (for public companies only), who will be subject to a 6-month delay before receiving benefits, in certain circumstances
• Permit changes in distribution elections by 12/31/08 for prior elections made regarding the time and form of payment for amounts previously deferred (subject to certain limitations)
• Establish a 409A compliance program—policies, practices and procedures that are reasonably designed in order to ensure compliance with 409A, in order to preserve eligibility to participate in current and future corrections programs that may be established by the IRS to address inadvertent and operational errors

It also contains checklists for 403(b) plans and health and welfare benefit plans.

2008 End of Year Checklist

2008 End of Year Plan Sponsor "To Do" Lists provides a checklist of items for plan sponsors to address by the end of the year. If you have a different plan year, some of the due dates will be different.

• All Qualified Plans list
  
• Adopt Design Changes by End of Plan Year
• Adopt EGTRRA Restatement if in Cycle C
• Review 2009 Plan Limits
• Adopt Amendments Complying with the Final Section 415 Regulations
• Adopt Pension Protection Act Amendments
• Comply with HEART Act Changes
• Consider Amending Qualified Plans to Clarify Definition of Spouse
• Consider Whether the New Aggregation Rules for Tax Exempt Entities Apply
• Update Notice to Participants of Consequences of Failing to Defer
• Conflicted Plan Fiduciaries Should Review Investment Advice Programs
• Begin Identifying Service Provider Contracts To Which New Fee Disclosure Rules Apply
• Comply with New Rules Requiring Disclosure of Plan and Investment-Related Information for Participant Directed Individual Account Plans
• Comply with Items on All Qualified Plans List
• Provide Section 401(k)/401(m) Safe Harbor Notice by December 2, 2008 for Calendar Year Plans
• Provide Annual Automatic Enrollment Notice by December 2, 2008 for Calendar Year Plans
• Provide Annual Qualified Default Investment Alternative Notice by December 2, 2008 for Calendar Year Plans
• If Adding Qualified Automatic Contribution Arrangement or Eligible Automatic Contribution Arrangement for 2009, Adopt Amendment Before the 2009 Plan Year
• Adopt Amendment Conforming Section 401(k) Definition of Compensation
• Comply with Additional HEART Act Changes
  
  
• 401(k) Plans list
  
  
• Comply with Items on All Qualified Plans List
• Provide Section 401(k)/401(m) Safe Harbor Notice by December 2, 2008 for Calendar Year Plans
• Provide Annual Automatic Enrollment Notice by December 2, 2008 for Calendar Year Plans
• Provide Annual Qualified Default Investment Alternative Notice by December 2, 2008 for Calendar Year Plans
• If Adding Qualified Automatic Contribution Arrangement or Eligible Automatic Contribution Arrangement for 2009, Adopt Amendment Before the 2009 Plan Year
• Adopt Amendment Conforming Section 401(k) Definition of Compensation
• Comply with Additional HEART Act Changes
  
  
• Other Defined Contribution Plans list
  
  
  • Comply with Items on All Qualified Plans List
  • Provide Annual Qualified Default Investment Alternative Notice by December 2, 2008 for Calendar Year Plans
    
    
• Executive Compensation list
  
  
  • Nonqualified Deferred Compensation Plans Must be Amended by December 31, 2008 to Comply with Section 409A
  • Identify Plans or Arrangements Subject to Section 409A
  • Changes to Certain Elections under Section 409A Plans Must be Made by December 31, 2008
  • Consider Adopting Universal Section 409A Resolution
  • Public Companies Must Review Severance, Change in Control or Other Section 162(m) Performance-Based Arrangements for New Rules before December 31, 2008
  • Consider Shareholder Reapproval of Section 162(m) Performance Compensation Plans Approved in 2004
  • Code Section 6039 Information Statements Due by January 31, 2009
  • Review Stock Option Grant Procedures for Upcoming Grants

The document also contains checklists for defined benefit plans, Section 403(b) and Section 457(b) plans, and health and welfare plans.

Tax Impact of Tribune Bankruptcy, LLCs and Employee Ownership, and the Latest 409A Proposed Regulations

The December 15, 2008 Employee Ownership Update is online and discusses the following:

• Tribune Company Bankruptcy and the ESOP
• Employee Ownership in LLCs
• IRS and Treasury Release Proposed Section 409A Income Inclusion Regulations
• Apply Soon for Winning Workplaces Awards
  

The Update discusses how the bankruptcy filing of the Tribune Company will have a nominal net impact on the retirement plans of the Tribune Company employees and notes that this didn't stop members of the media from providing false information as part of its Sensational Anti-ESOP Coverage. The Update stresses the importance of the ESOP community Countering Negative ESOP Coverage with the Facts and getting the real ESOP story out to the decision makers. It also discusses some complex tax issues that the Tribune bankruptcy may trigger:

The bankruptcy may trigger some complex tax issues. As a 100% S ESOP, the Tribune has just one shareholder. But if the reorganization is structured so that there are more than 100, or one or more owners are not qualified S owners (such as non-U.S. citizens or non-tax-paying entities), the S election will be broken, causing potential taxation issues. In addition, if the company's assets are sold, there could be built-in gains taxes if the benefit is greater than the company's taxable income (a very likely scenario). Cancellation of debt could also trigger tax issues.

The Update also discusses employee ownership in LLCs.

Limited liability companies are a popular form of corporate organization for smaller companies. They are taxed in much the same way S corporations are taxed, but, unlike S corporations, they do not have to distribute earnings pro-rata to owners. If you search the Web for employee ownership in LLCs, you'll find almost every article suggesting that it is best to convert to S or C status to make it more practical. In fact, however, LLCs can have forms of broad-based equity sharing. Capital interests work similarly to restricted stock and profits interests similarly to stock options. More common, however, would be an LLC unit that would function in much the same way as phantom stock or stock appreciation rights and be paid out in cash. The "interests" approaches raise some tax uncertainties that, while subject to common practice, are still mostly governed by proposed regulations that were never finalized.

In a related discussion, IRC Section 1042 Tax Deferred Sale of Stock to an ESOP and Private Letter Ruling (PLR) 200827018 Involving a Predecessor LLC discusses how a private letter (PLR) ruling allowed two selling shareholders of a C Corporation to include the time period that they owned a predecessor LLC that was merged into a newly created C Corporation in the 3-year holding period. This strategy may be useful if a LLC decides it would like to sponsor an ESOP in the future.

The Update also discusses the latest proposed IRC Section 409A Nonqualified Deferred Compensation (NQDC) Plan Regulations, effective January 1, 2009. IRS Notice 2008-113 – Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with § 409A(a) in Operation provides some initial guidance on the calculation of 409A income and related taxes. IRS Notice 2008-115 – Reporting and Wage Withholding Under Internal Revenue Code § 409A provides an enhanced correction program for certain operational errors.