There are a variety of options for ESOP companies looking to maximize stock allocations to active participants, minimize stock allocations to terminated participants, and efficiently use the cash within the trust to accomplish these objectives. This article briefly looks at two of them.
“Reshuffling” The Pile
In what the IRS refers to as reshuffling, the ESOP exchanges the stock in a terminated participant’s account with cash from active participants’ accounts. This is carried out as of the end of the plan year in which the participant terminates employment, regardless of when they will be eligible to receive a payment from the ESOP.
The option can benefit both active and former employees. It maximizes the amount of stock in the accounts of active participants, who can benefit from increasing stock values, and protects former employees from potential decreasing stock values (although they wouldn’t share in future gains).
Reshuffling is also a classic strategy for managing the repurchase obligation because it provides for the purchasing of shares at the current fair market value.
This option may not be preferred for the ESOP that is looking to accumulate cash for use in purchasing additional stock. If the company is in a position to fund enough cash to the ESOP to accommodate both objectives (cashing out terminated accounts and accumulating cash for a stock purchase) then this may not be a concern.
Immediate Payout For Cash Accounts
The ESOP may also be amended to allow terminated participants to request a distribution from only their reshuffled cash account at any time following the year in which they leave the company. This option coordinates with reshuffling and is drafted to provide that to the extent a participant’s account is moved into cash, the participant may request a payment from their cash account.
Historically, a company would amend the ESOP’s distribution provisions to provide earlier payouts to terminated participants as cash is available. However, this can pose a problem since the amount of cash available fluctuates on an annual basis and some companies don’t want to have to amend their plan or distribution policy every year. In addition, annual amendments to the distributions provisions (whether in the plan or in an outside distribution policy) may run afoul of the protected benefit rules under certain Treasury regulations. The IRS expressed this concern to us. The IRS also recently confirmed that changes to a distribution “policy” that are not contained in a plan document (not our advised practice) are treated the same as amendments to the plan document and are subject to these rules.