ESOP Planning 2008: Distributions (3 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:

• For plans that have not started to pay distributions, do you have distribution forms and the required disclosures ready to distribute to participants? Does your IRC Section 402(f) Special Tax Notice satisfy all of the legal requirements, noting that IRS Notice 2002-3 - Safe Harbor Explanation - Certain Qualified Plan Distributions does not include required legislative changes such as automatic rollovers and rollovers to Roth IRAs.
  
  Does the rest of your distribution paperwork satisfy the legal requirements? TAM: ESOP Stock Distributions Subject to Immediate Put Option to Company are Indeed Stock Distributions Eligible for Net Unrealized Appreciation (NUA) discusses a technical advice memorandum (TAM) that details the steps a company took and forms it used to offer share distributions with an immediate put back to the company.
  
  Is the paperwork in a format that the participants will be able to understand? Have you anticipated the questions that you will get from the participants, and have you determined your communication strategy to answer them (e.g., providing an explanation during the exit interview, providing additional paperwork to assist the participants, providing a telephone number for the participants to call with questions)?
  
  
• Are you paying distributions using the most current fair market value? If you are paying distributions to participants based on their December 31, 2007 account balances (assuming a December 31 plan year end and an annual stock appraisal), then a participant should not be paid after December 30, 2008 based on the December 31, 2007 balance. While this is the minimum requirement, you will also need to address whether the value is "stale."
  
  
• Is the fair market value that you are using an accurate reflection of the market value or has the value become "stale"? If you pay someone a distribution on December 15, 2008, based on the December 31, 2007 stock value, the value is almost 350 days old. Some experts would argue that you are not paying the participant at fair market value. Does a stock value become "stale"? If so, when? There is no clear guidance in this area, and the determination of if and when a value becomes "stale" is subjective and is based on the facts and circumstances of your situation.
  
  Make sure you learn from the takeaways from DelRosario and Taylor v. King & Prince Seafood Corporation.
  
  
• Are any participants due to receive required minimum distributions (RMDs)? The IRS requires that participants must begin taking Required Minimum Distributions (RMDs) once they reach age 70½. The actual date that they must begin receiving RMDs is generally no later than the April 1 after the later of reaching age 70½ and the date of termination (unless you are a 5% owner, in which case you must begin receiving RMDs regardless of your termination date). They must continue to receive RMDs each December 31 until they no longer have an account balance. The value of the RMD is calculated based on actuarial tables provided by the IRS, the age of the each beneficiary (if any), and the beneficiary's relationship to the participant. You should carefully analyze the RMD status of all employees age 69 and older so you are not caught off guard. If the participant does not take the RMD each year, the participant will owe a 50% penalty on the amount her or she should have withdrawn and the plan risks becoming disqualified. Check out this most recent Required Minimum Distributions (RMDs) update.
  
  The economic downturn has created a push to waive RMDs. Make sure you are aware of the impact that H.R. 7327: Worker, Retiree, and Employer Recovery Act of 2008 (WRERA) will have on RMDs. 2009 RMDs were waived by WRERA, but the 2008 RMDs were not waived (though some discussions continue).
  
  
• 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). RMDs – How many shares to distribute? provides an example of how to determine the number of shares.
    

  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.
  

The fourth installment of ESOP Planning 2008: Distributions will discuss the following question:

Do you have any participants who are eligible to diversify a portion of their account balances?

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.