By now, all companies sponsoring ESOPs should be aware that their plan documents must be restated and submitted to the IRS every five years for a letter of determination of their tax qualified status. What they may not realize is that the ESOP restatement process offers potentially unrealized opportunities for cost efficiency, employer protection and creative re-design.
Who Can Benefit?
Restated ESOP plan documents must be submitted to the IRS in one of five annual "cycles," A through E, based on the employer identification number. We are now in "Cycle D" again. If your EIN ends in 4 or 9, your time is now. You will be submitting your restated ESOP plan document to the IRS before January 31, 2015. Next up will be Cycle E filers, with EINs ending in 5 or 0. Submissions have slowly worked their way through the IRS review process but now, the IRS is promising, the time required to process the submission is being reduced. In the meantime, since all companies go through changes, new planning strategies are being developed by ESOP experts, and ESOP programs must evolve. Cycle D filers are immediately poised to take a closer look at the design potential possibilities for cost savings and fiduciary protection. For every company, the process begins by asking the right questions – some technical; and some design oriented.
Who's Got Your Back?
The proper approach begins with a team discussion with the company's internal administration staff, plan fiduciaries, the third party administrator (TPA), and ESOP counsel responsible for rewriting the plan. Simply using a boilerplate ESOP document or restating the plan document "as is" will leave planning points on the drafting table, if they are even spotted. That's why all of the company's advisors must bring to bear their experience with the company's historical operation and the potential issues that may come up due to the employer's ever-changing circumstances.
Given our changing economic times, this approach will help identify any and all flexibility or modifications to your plan that you should consider. There have been recent developments in plan design and administration that the IRS is now wiling to approve and which are worth considering.
Are The Trust And Fiduciary Provisions Sound?
Have the plan's trust and fiduciary's provisions been examined to address such subtleties as who is directing whom, their indemnification provisions (which, by the way, are currently the subject of controversy in the federal courts), or potentially the need for external fiduciaries or trustees, which will require significant alterations to your ESOP document and trust document? For example, how does a fiduciary invoke his or her indemnification? How does this mesh with your fiduciary coverage?
Can You Save Money By Combining Or Coordinating Plans?
Is the company maintaining a 401(k) plan in addition to its ESOP? Should the plans be combined? Should the profit sharing component of the 401(k) plan or its matching provisions be used differently to allocate benefits that are currently held in the employee's stock accounts? Will combining plans save administration costs? Some of these planning points fly in the face of conventional wisdom, which argues for separating 401(k) and ESOP plans. But in changing times, traditional assumptions should be questioned. More recently 401k ESOPs or "KSOPs" have become more common. In addition, are you coordinating your ESOP and 401(k) design? Are you funding a match or safe harbor contribution to the 401(k) that could be funded to the ESOP. It may be the right time to have both of your retirement plans on one platform to deliver better results to your employees.
How Can Profit Sharing Or Stock Bonus Plans Be Helpful?
Should the ESOP contain a profit sharing plan or stock bonus plan to allocate stock benefits differently? Profit sharing plans or stock bonus plans can use different allocation formulas that are not available to ESOPs. They can both be a part of your ESOP plan document. More creative plan design may be important for those most valuable employees whom you need to reward and retain.
What Can You Do Now To Facilitate Future Repurchase Liability?
Are the plan's distribution and diversification provisions best drafted for the company's current circumstances? Is this the right time to make changes to distribution provisions or policies, (which should be adopted by the employer and not the plan fiduciaries), to ensure that future repurchase liability or corporate strategic planning are facilitated? For example, is it desirable to retire or redeem shares rather than re-circulate shares while stock prices are low to allow an ascending value of benefits when stock values improve? Are you taking full advantage of the latest trust accounting alternatives to address who should and shouldn't be invested in company stock? Are you proactively dealing with new employees and their desire to receive significant share allocations?
How Can I Use The Process To Be Ready For An IRS Audit In The Future?
Have there been plan administration procedures applied by the company's TPA that don't strictly follow the terms of the plan document? Is there a need for a "reformative amendment" to be adopted as part of the plan restatement that must be submitted as an EPCRS filing in tandem with the determination letter Form 5300? In most cases, it's not terribly costly, and it's cheap insurance against an IRS audit. Take advantage of it now.
And What If There Is A DOL Investigation?
Are all of the company's ESOP transaction documents, trustee minutes and director's minutes in order in the event of IRS or DOL audit or investigation? As we will detail in an upcoming article, we are seeing renewed enforcement interest in ESOP administration and transactions.
But We've Already Submitted … Now What?
All of these are great planning pointers if you are in Cycle D and about to go through the restatement and submission process. We have found that in the past, the determination letter process was excruciatingly slow, however, the IRS has recently made significant progress in this regard.
If your determination letter filing is still open, you may wish to go back and reconsider some of the issues raised in this article, and see if there is anything that might be worth revising or adjusting. It is possible to make supplemental submissions to the IRS while your Form 5300 is still being processed. The IRS will incorporate such changes into your plan document and issue the final determination letter based upon all of the elements of your submission.
You are required by law to go through the restatement process every five years. There is no reason to do it half-heartedly. Much thought may have been put into your ESOP at the front end. However, times have changed and so have your ESOP issues and needs. All ESOP sponsors should turn this exercise into an advantage.
For further information on the nuances of plan design as it is impacted by plan administration, contact us for a reprint of our in-depth article published in the National Center for Journal Of Employee Ownership Law and Finance, Vol. 20, No. 3, "Designing And Drafting ESOPS," or contact us for general information at firstname.lastname@example.org.