Qualifying Employer Securities Project Summary
Defined benefit plans and post–ERISA money purchase pension plans need to comply with ERISA section 407(a) (2) which provides that plans may not acquire qualifying employer securities if immediately after such acquisition the aggregate fair market value of the qualifying employer securities and qualifying real property held by the plan exceeds 10% of the fair market value of the assets of the plan. ERISA sections 407(b)(1) and 407(d)(3)(B) permit eligible individual account plans, which include profit-sharing plans, 401(k) plans, ESOP plans, stock bonus plans and pre-ERISA money purchase plans in existence on September 2, 1974, to hold qualifying employer securities without regard to the 10% limit if the plans explicitly provide for the holding of employer securities.
No Form 5330 returns were actually secured. Only five sponsors of defined benefit plans and one defined contribution plan sponsor in our total sample consisting of 32 defined benefit plans and 362 individual account plans failed to meet the exemptions of Code Section 4975(d)(13) and section 408(e) of ERISA. Excise taxes under Code section 4975(a) could not be collected in these cases due to the statute of limitations. However five out of the six plan sponsors made corrections. Only one of the defined benefit sponsors failed to resolve the prohibited transaction and as a result, the Project Manager made a Request for Examination.
Approximately two thirds of the plan sponsors in the sample turned out to be sponsors of ROBS plans. Responses to the compliance check questionnaires indicated that Employer Securities in ROBS plans were initially valued by the amount of paid in capital included in the rollover and additional employer contributions on the date of the business commencement. The IRS held that the initial stock valuation method was acceptable. The ROBS plans were not subject to the 10% rule and in no cases were commissions paid to obtain the stock. Therefore prohibited transactions were not the issue. The issue was with subsequent year stock valuations. With few exceptions, the plan sponsors of ROBS plans were not valuing their Employer Securities in a systematic way on an annual basis and were not valuing Employer Securities at fair market value as required under Revenue Ruling 80-155. Some plan sponsors were using the book value of the corporate assets as the value of the Employer Securities. Other plan sponsors were using the same value as the initial value year after year.
The Project Manager and Assistant Project Manager addressed the issue of valuing Employer Securities at fair market value in the closing letter. The Project Manager and Assistant Project Manager referred several ROBS plans to EP Field Exam, when it was determined that there were issues in addition to valuation issues. Referrals were most often made for the following reasons:
- Potential coverage issues under Code section 410(b)
- Potential discrimination issues under Code section 401(a)(4)
- Evidence of large losses or large withdrawals from the plan
- Failure of the plan sponsors to respond to the compliance check after receiving a follow-up letter by certified mail.
Approximately 26% of the plans in our sample resulted in “no change” closures. The “no change” cases consisted of three ROBS plans. Although ROBS plans made up approximately 2/3 of the total sample size, the percentage of ROBS plans that were closed “no change” were less than 1% of the total sample size.
Approximately 41% of the plans in the sample resulted “correction of operational practice /futures impact” closures”. The sponsors of these plans received closing letters with advisory comments. Four of these cases were defined benefit plans that exceeded the 10% limit 15 or more years ago. Almost all of the other cases in this category were ROBS plans that failed to value Employer Securities annually at fair market value
Approximately 17% of the plans resulted in referrals to the EP field exam. One plan that was referred was a large 401(k) plan that valued “goodwill” as an asset on the balance sheet. All of the other referrals were ROBS plans.
Based on the taxpayer responses, the focus of the project switched from identifying plan sponsors who engaged in prohibited transactions as a result of the plan investing in Employer Securities and collecting excise tax under Code section 4975, to addressing the issues of ROBS plans.
Code section 4975(d)(13) refers to ERISA section 408(e) which provides that the acquisition by a plan of Employer Securities is exempt from being a treated as a prohibited transaction subject to excise tax under Code section 4975(a) if the following conditions apply:
- the Employer Securities are acquired for adequate consideration (acquired at fair market value),
- no commissions are paid to plan associates to acquire the Employer Securities and
- the acquisition is in compliance with ERISA Section 407 as outlined above.
The Qualifying Employer Securities project was designed to identify plans, other than stock bonus and ESOP plans, that invest in Employer Securities in order to determine whether the sponsors of these plans engaged in a prohibited transaction at the time these plans acquired Employer Securities. If it were determined that a plan sponsor did in fact engage in a prohibited transaction, the EPCU was to determine whether the plan sponsor filed a Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans) and paid the correct amount of excise tax in each applicable year. The EPCU was to solicit Forms 5330 from those plan sponsors that engaged in prohibited transactions and failed to file Forms 5330 in each of the open years in which the prohibited transactions occurred.
The contact letter sent to plan sponsors requested information which included the following:
- The dates on which Employer Securities were acquired, the dollar amount of Employer Securities acquired on each date and the cumulative value of Employer Securities held in the trust after each acquisition.
- The value of the end of year Net Assets in each of the years in which Employer Securities were acquired.
- Whether or not the Employer Securities were valued at Fair Market Value and a description of steps taken to value the Employer Securities
- Whether or not commissions were paid to acquire the Employer Securities.
And if the plan is an eligible individual account plan,
- Whether or not the plan specifically provides for acquisition and holding of Employer Securities in excess of 10% of plan Assets and a summary of the language in the Plan document that permits holdings of Employer Securities.
In the typical ROBS plan, no contributions are being made after the initial rollover contribution. Employees hired after the plan’s inception do not have the opportunity to participate in the plan. The failure to include employees in the plan is usually a coverage issue. In a small percentage of ROBS plans in the sample, employees were participating in the plan and were able to invest in various public mutual funds. However these employees do not have the opportunity to invest in Employer Securities and benefit from their appreciation along with the highly compensated employee. This differential treatment appears to be a 401(a)(4) violation.