Chapter 7: Employee Stock Ownership Plans (ESOPs)

Question 1

To satisfy the diversification requirements, a plan must offer three investment alternatives other than employer stock.

True or False?

Answer 1

False. A plan need not offer other investment alternatives — it could instead offer a cash distribution and/or a transfer to another qualified plan that offers such investment alternatives. IRC 401(a)(28)

Question 2

Leveraged ESOPs must take a loan from a commercial source.

True or False?

Answer 2

False. The loan can come from any source, as long as it is an arms-length transaction.

Question 3

ESOPs cannot be integrated using permitted disparity.

True or False?

Answer 3

True

Question 4

For publicly traded stock, voting rights must be passed through to the participant in the ESOP.

True or False?

Answer 4

True

Question 5

For closely held stock, voting rights must be passed through to the participant in the ESOP.

True or False?

Answer 5

False. Only on certain issues must voting rights be passed through to shareholders.

Question 6

S corporation ESOPs are prohibited from distributing benefits in the form of stock. True or False?

Answer 6

False. IRC regulations exempt S corporation ESOPs from the requirement of distributing benefits in the form of stock. S corporation ESOPs generally distribute cash in lieu of stock but they are not prohibited from distributing benefits in the form of stock.

Question 7

Stock bonus plans may make distributions in employer stock.

True or False?

Answer 7

True

Question 8

ESOPs invest primarily in employer stock.

True or False?

Answer 8

True

Question 9

Many employers can contribute more to an ESOP than to other defined contribution plans.

True or False?

Answer 9

True

Question 10

A participant who is age 55 is eligible for IRC §401(a)(28) diversification.

True or False?

Answer 10

False. A participant must be age 55 with ten years of plan participation to be subject to the diversification requirements of IRC §401(a)(28).

Question 11

The IRC §4978 tax is payable by the employer, using Form 5330, and is due by the end of the 7th month following the close of the employer’s taxable year in which the disposition occurs. True or False?

Answer 11

True

Question 12

Dividends paid to an ESOP may be tax deductible to the employer.

True or False?

Answer 12

True

Question 13

If an ESOP makes a prohibited allocation or accrual, an excise tax equal to 50 percent of the accrual is imposed on the S corporation, and the disqualified person is deemed to have received a distribution in the amount of the prohibited allocation.

True or False?

Answer 13

True

Question 14

The definition of family used in IRC §409(p) is much broader than other definitions of family used under other attribution rules that apply to qualified plan requirements.

True or False?

Answer 14

True

Question 15

Which of the following statements regarding ESOPs is NOT TRUE?

A. A money purchase pension plan can include an ESOP provision.
B. A 401(k) plan can include an ESOP provision.
C. An ESOP can allocate contributions using permitted disparity.
D. The deduction limit may exceed 25 percent of compensation in some ESOPs.

Answer 15

C. ESOPs may not use permitted disparity in their allocation formulas.

Question 16

Which of the following statements regarding ESOP diversification under IRC §401(a)(28) is NOT TRUE?

A. The right to diversify must be provided annually for six years.
B. Qualified participants must be able to diversify a total of 25 percent of their account balance for five years, and 50 percent in the sixth year.
C. Diversification must be provided at age 55 and ten years of service.
D. In the final election year, the participant must be able to diversify 50 percent of his or her account balance invested in employer stock.

Answer 16

C. Diversification is available to participants age 55 with ten years of participation, not service.

Question 17

Based on the following information, determine the number of shares currently available for diversification.
*Participant A’s account contains 20,000 shares valued at $2 per share.
*Participant A is age 59 with 20 years of participation.
*Two years ago, Participant A diversified 1,500 shares valued at $4 per share.

A. 2,750
B. 3,500
C. 3,875
D. 5,000

Answer 17

C. Participant A is eligible to diversify a total of 25 percent of the account balance. The total balance is the current balance of 20,000 shares plus the 1,500 shares that were diversified two years ago for a total of 21,500 shares. 25 percent of 21,500 shares is 5,375, less the 1,500 already diversified, leaves 3,875 available for diversification.

Question 18

Which of the following statements regarding leveraged ESOPs is NOT TRUE?

A. ESOP loans may be back-to-back loans.
B. The shares purchased by the ESOP are security for the loan.
C. Loan proceeds may be used to repay another exempt loan.
D. Employer securities that are used as collateral are allocated to eligible participants.

Answer 18

D. Employer securities that are used as collateral must be held in a suspense account and are not allocated securities.

Question 19

Which of the following statements regarding calculating net unrealized appreciation (NUA) on a stock distribution is NOT TRUE?

A. It is the difference between the value of the employer stock at the time of distribution minus the plan’s cost basis in the stock.
B. If the employer stock is rolled over to another qualified plan, the recipient plan’s cost basis is equal to the value of the employer stock at the date of rollover.
C. A participant who received a lump sum distribution that includes employer stock, may elect to exclude from gross income the entire NUA.
D. A participant who receives a distribution prior to age 59½ and includes employer stock will be subject to the 10% tax on early distribution on the NUA portion that is excluded from income.

Answer 19

D. The participant is not subject to the 10% tax on early distribution on the NUA that is excluded from income. The penalty only applies to the taxable portion of the distribution.

Question 20

All of the following statements regarding distributions from an ESOP are TRUE, EXCEPT:

A. Generally, ESOP participants have the right to demand that their entire account be distributed in the form of employer securities.
B. A put option permits the holder of the stock to demand that the company buy back the stock at the current fair market value.
C. Special tax rules apply to determine income tax withholding requirements on a distribution that includes employer securities.
D. For separations due to retirement the distribution of the participant must have the right to elect a distribution within one year after the fifth plan year following their separation.
E. If an ESOP is leveraged, the ESOP may be permitted to delay distributions of securities to participants until the loan is completely repaid.

Answer 20

D. For separations due to retirement the distribution of the participant must have the right to elect a distribution within one year.

Question 21

All of the following statements regarding leveraged ESOPs are TRUE, EXCEPT:

A. The ESOP may delay distributions until the loan is completely repaid.
B. Through a leveraged ESOP the employer may have access to additional funds, such as those needed for expansion, on a tax-favored basis.
C. When an ESOP company borrows to purchase stock, the bank may require additional security for the loan other than the stock that is purchased with its proceeds.
D. Dividends paid on unallocated stock held in the suspense account may be used to make repayments on that loan.
E. The ESOP loan must be for the primary benefit of the participants and beneficiaries.

Answer 21

C. When an ESOP company borrows to purchase stock, the only security for the loan is the stock that is purchased with its proceeds.

Question 22

Which of the following statements regarding ESOPs is/are TRUE?
I. If an ESOP holds privately held employer securities it is required to have the stock valuation completed by an independent appraiser.
II. The reinvested distributable dividends of a participant must be fully vested even if the participant is not otherwise fully vested.
III. Reasonable commissions may be paid with respect to an ESOP acquiring employer securities from a disqualified person.

A. I only
B. III only
C. I and II only
D. II and III only
E. I, II and III

Answer 22

III is FALSE. NO commissions may be paid with respect to an ESOP acquiring employer securities form a disqualified person.

Question 23

All of the following statements regarding IRC §1042 transactions are TRUE, EXCEPT:

A. Shareholders who sell their interest to the ESOP may be able to defer the gain for a
significant period of time if the sponsoring company is a C corporation.
B. Shareholders must own at least 10% of the stock to take advantage of this election.
C. Eligible shareholders may sell stock to the plan and reinvest the proceeds in equity or
debt instruments.
D. IRC §1042 transactions are valuable to business owners that want to divest their stock.
E. The shareholder must reinvest the proceeds of the sale of stock to the ESOP in qualified
replacement property.

Answer 23

B. Shareholders must own at least 30% of the stock to take advantage of the IRC
§1042 election. Excise tax is 10% of the amount realized on the disposition.

Question 24

All of the following statements regarding distributions from an ESOP are TRUE, EXCEPT:

A. Generally, ESOP participants have the right to demand that their entire account be
distributed in the form of employer securities.
B. A put option permits the holder of the stock to demand that the company buy back the
stock at the current fair market value.
C. The ESOP does not need to distribute stock when the company by laws limit stock
ownership to the ESOP and employees of the company.
D. For separations due to retirement the participant must have the right to elect a
distribution within one year after the fifth plan year following their separation.
E. S corporations are exempt from distributing benefits in the form of stock.

Answer 24

D. For separations due to retirement the distribution of the participant must have the
right to elect a distribution within one year after the close of the plan year in which
he separated for retirement.