Segregation of Accounts and Rebalancing/Reshuffling Update

Posted by Aaron Juckett, CPA, CPC, QPA, QKA on Wed, Dec 02, 2009
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The December 1, 2009 Employee Ownership Update is online and discusses the following:

  • New Charles Schwab Study Looks at Trends in Equity Compensation in Large Companies
  • ESOP Account Segregation, Rebalancing Update
  • Beyster, Kelso, and Smiley Fellowship Applications Sought

Here is a brief description of segregation of accounts and rebalancing:

Segregation of Accounts

  • Segregation of accounts occurs when the company buys all or some of the shares of the accounts of participants that have separated service from the company. The cash is invested in other prudent investments until distribution.
  • Segregation of accounts prevents former employees from sharing in future gains.
  • Segregation of accounts protects former employees from sharing in future losses in the value of the company and provides them with additional diversification.
  • This strategy is used by many ESOP companies to manage their repurchase obligation, enabling them to purchase the shares of terminated participants at the current fair market value. This approach essentially speeds up the repurchase obligation to the time of segregation. Assuming an increasing stock value, this strategy accelerates your repurchase obligation in the short-term and reduces it in the long-term.
  • Segregation can also free up more shares for allocation.

Rebalancing/Reshuffling

  • When a plan rebalances, shares are "reshuffled" as needed so each participant will has the same proportion of cash and stock at the end of the plan year. The reshuffling is processed with an internal repurchase of shares (a.k.a recycling).
  • This approach provides a method to get shares to newer employees and help manage the "haves vs. have nots" scenario that occurs in many mature ESOPs.
  • This IRS has stated that this approach cannot be used to solve IRC Section 409(p) Anti-Abuse Testing issues.

The Update provides the latest on the IRS Position on Rebalancing and/or Segregation Plan Provisions:

Some months ago, there was optimism that the IRS would issue some kind of pronouncement on what approach it would take toward ESOP account segregation or rebalancing…The IRS had not been issuing letters of determination for plans with segregation provisions, although there was no official policy to this effect. But in the last several weeks, there have been reports that its concerns have been mollified. One concern was that employees would be impaired in their ability to demand a distribution in the form of company stock. While they could make that demand, if the plan used the cash to buy shares from the company, the basis for those shares could be much higher than it would have been if the account had stayed in company stock. Companies can solve this problem by reacquiring shares from accounts in the plan that have a basis as close as possible to the participant's basis at the time of segregation.

The IRS approach on rebalancing is also ambiguous. Rebalancing is not allowed to solve anti-abuse problems in S ESOPs, but many companies do have this feature in their plans for other purposes. Some IRS officials have informally said they may want to evaluate if rebalancing is consistent with ERISA, but there have been no indications that plans with these provisions have faced any specific problems.


The Update also discusses how fellowship applicants are being sought for 11 fellowships for the 2010-2011 academic year to "outstanding PhD candidates or post-doctoral scholars studying broadening the ownership of capital assets among members of a democratic society, such as employee ownership, profit sharing, and broad-based stock options in the corporation." It also discusses the results of a study, Taking Stock: Examining the Role of Corporate Stock Plan Benefits in the Workplace, that shows that "most companies offer stock plan benefits to motivate and provide a sense of ownership among employees."

Topics: Studies and Statistics, ESOP, employee stock ownership plan

Aaron Juckett, CPA, CPC, QPA, QKA
Written by Aaron Juckett, CPA, CPC, QPA, QKA

Aaron is President and Founder of ESOP Partners and provides implementation, administration, and consulting services to hundreds of companies. He is a member of The ESOP Association (TEA) and the National Center for Employee Ownership (NCEO).

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