Now that we are mid-way through 2012, I thought it would be a good time to write a series of blogs on ESOP Distributions, as most calendar year plans are in, or will soon be in, their ESOP distribution processing season.
Forms of ESOP Distributions
IRC Section 409(h) states an ESOP participant can request a distribution in stock from the plan and requires the employer to buy the distributed shares from the participant.
(h) Right to demand employer securities; put option
(1) In general
A plan meets the requirements of this subsection if a participant who is entitled to a distribution from the plan—
(A) has a right to demand that his benefits be distributed in the form of employer securities, and
(B) if the employer securities are not readily tradable on an established market, has a right to require that the employer repurchase employer securities under a fair valuation formula.
Exceptions to Stock Distributions
The Internal Revenue Code goes on to list a couple of exceptions to the stock distribution requirement in IRC Section 409(h)(2) and IRC Section 409(h)(3). Stock distributions do not have to be made to ESOP participants where the plan sponsor:
Has a charter or bylaws that restrict the ownership of substantially all outstanding employer securities to employees or to a qualified plan trust;
Is a bank that is prohibited from purchasing their own stock; or
Is a S Corporation (although an S Corporation may still distribute stock with the requirement that it be immediately sold to the company or ESOP)
If a stock distribution will not be available due to an exception above, the ESOP participant must have a right to receive the distribution in cash.
Regardless of the distribution being paid in stock or cash, the plan sponsor has to plan for the redemption of the stock or getting cash in the plan to fund the distributions. This is what is known as the ESOP Repurchase Liability.
There can be some flexibility in the form of ESOP distributions. Most plan documents will indicate distributions can be made in the form of stock or cash. Creating a written distribution policy to compliment the plan document and further define the form(s) of distributions being offered to plan participants is a best practice and a good way to communicate the current distribution process to the ESOP participants.