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ESOP Operational Issues

Allocation Restrictions Triggered by a Section 1042 Sale to an ESOP (Part 3)

Nancy Dittmer

June 16, 2010

(Nancy Dittmer)Let us continue the discussion of the non-allocation restrictions of Code Section 409(n) by defining a more-than-25% shareholder for this purpose. A person will be considered a more-than-25% shareholder if he or she owns more than 25% (in terms of either number of shares or value) of:

Indirect ownership is considered as well as direct ownership. An individual is considered to indirectly own the shares that are owned by the following related individuals or entities:

An individual will be considered a more-than-25% shareholder if he or she owns, directly or indirectly, more than the 25% at any time during the one-year period ending on the date of a particular Section 1042 sale. If a person meets this criterion, he or she is prohibited from ever receiving an allocation of the Section 1042 shares acquired in that transaction.

A person may become a more-than-25% shareholder in the future as the shares acquired in a leveraged Section 1042 transaction are still being allocated among ESOP participants. This is important because any participant who is a more-than-25% shareholder on the date of any allocation of the Section 1042 shares cannot receive an allocation of those shares. Note that the shares in a participant's ESOP account are considered to be owned by such person for purposes of this test. Hence, it is possible that the ESOP allocations will cause a person to become a more-than-25% shareholder and become ineligible for further allocations of 1042 shares. Although this is not entirely clear, an ESOP participant should be able to receive an allocation of shares that causes him or her to exceed the 25% limit with future allocations ceasing at such point (unless and until the ownership drops below 25% at some point in the future).

There are a few miscellaneous questions I would like to address:

If a violation of Code Section 409(n) has occurred, you should consult with your ESOP advisors on possible correction alternatives.

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