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As mentioned in my previous post, ESOP plan documents will typically indicate the share release formula can be either of the two acceptable formulas, as defined in the Treasury Regulations Sec. 54.4975-7(b)(8):

  • General rule (also known as the Principal and Interest Method)

  • Special rule (also known as the Principal Only Method)

The Special rule share release formula is based solely on principal payments made on the ESOP loan:

(principal paid for the year) / (principal paid for the year + principal to be paid for all future years) * shares in suspense

As noted in the Treasury Regulations mentioned above, if the release is determined with reference to principal payments only, three additional rules must be followed:

  • The loan must provide for annual payments of principal and interest at a cumulative rate that is not less rapid at any time than level annual payments of such amounts for 10 years.

  • Interest included in any payment is disregarded only to the extent that it would be determined to be interest under standard loan amortization tables.

  • The term of the loan cannot exceed 10 years (including any renewal, extension, or refinancing)

Summary

It is critical to know what share release formula is cited in the ESOP loan documents (normally noted in the Pledge Agreement) to ensure your plan is being administered correctly in conjunction with the formula(s) allowed in the ESOP plan document. Failure to properly release shares will result in allocation errors and administration rework as required under Employee Plans Compliance Resolution System (EPCRS).

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