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Ms. Evelyn Petschek
Director, Employee Plans Division
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224
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Dear Ms. Petschek:
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On October 13, 1994, the Internal Revenue Service (the Service) issued
National Office Technical Advice Memorandum 9503002 (the TAM) regarding the
use of pre-tax salary reduction contributions to repay an exempt loan to a
leveraged ESOP. While the TAM was limited to the application of sections
401(a)(2) and 4975(e)(7) of the Internal Revenue Code of 1986 (the Code),
the issues addressed in the TAM also implicate the fiduciary provisions
under Title I of ERISA. As a result, the Department has received a number of
inquiries as to how the Department's analysis of the fiduciary provisions
under Title I comports with the Service's interpretation of Treasury
regulations, as reflected in the subject TAM. Inasmuch as the Department's
analysis under Title I differs from the Service's interpretation under the
Code, we request that the Service reconsider its views on this matter.
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Specifically, the TAM addressed the issue of the permissibility of the
application of pre-tax salary reduction contributions to the repayment of an
exempt ESOP loan under the exclusive benefit rule of section 401(a)(2) of
the Code and the regulation which provides the permissible assets for
repayment of an exempt loan at § 54.4975-7(b)(5). The Service concluded
that because such contributions constitute employer contributions under the
regulation at § 1.401(k)-1(a)(4)(ii), such contributions could be applied
to payments under an exempt loan without violating the exclusive benefit
rule under the Code.
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We believe the use of pre-tax salary reduction contributions for payments
under an exempt loan raises issues both with respect to the primary benefit
test under section 408(b)(3) of ERISA as well as with respect to the
exclusive purpose requirements of sections 403 and 404 of ERISA.
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Unlike the Service's position under the Code, it is the Department's view
that amounts that a participant pays to or has withheld by an employer,
whether pursuant to a salary reduction agreement or otherwise, for
contribution to an employee benefit plan constitute participant
contributions for purposes of Subtitle A of Parts 1 and 4 of Subtitle B of
Title I of ERISA and for purposes of the prohibited transaction provisions
of section 4975 of the Code. (See 29 C.F.R. 2510.3-102 and Preamble to Final
Regulations under Section 401(k), 53 FR 29660, (August 8, 1988)).
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Section 406(a)(1)(B) of ERISA prohibits the lending of money or other
extension of credit, including a guarantee of a loan,(1)
between a plan and a party in interest. An employer that sponsors a plan is
a party in interest with respect to the plan, under section 3(14)(C) of
ERISA. Therefore, a sponsor's loan to a plan or guarantee of a loan to a
plan would be prohibited in the absence of a statutory or administrative
exemption. Section 408(b)(3) of ERISA provides a conditional exemption for
loans to employee stock ownership plans if, among other requirements, the
loan is "primarily for the benefit of the participants and
beneficiaries."
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It is generally understood that an exempt loan to an ESOP is secured
primarily by an employer's guarantee of the loan and agreement to make
annual contributions to the plan sufficient to meet the plan's obligation to
repay the principal and interest due under the loan arrangement.(2)
As recognized in the TAM regarding the arrangement in question, the
employer, by using the salary reduction contributions to satisfy part of the
loan obligation, is able to reduce the total amount of matching and
discretionary contributions it must pay. The use of participant
contributions to repay the exempt loan thus serves directly to relieve the
employer of its obligation to contribute to the plan. In addition, such use
of participant contributions causes participants to forego other investment
opportunities which might prove more beneficial to the participants than the
securities purchased under the loan. For these reasons we do not believe
that a loan which is structured to be repaid with participant contributions
would satisfy the general requirement under ERISA section 408(b)(3) that an
exempt loan must be primarily for the benefit of the ESOP's participants and
beneficiaries.
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In addition, the Department believes that the use of the participant
contributions to repay the acquisition loan raises additional concerns under
sections 403 and 404 of ERISA. Section 403(c)(1) of ERISA provides, in part,
that:
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The assets of a plan shall never inure to the benefit
of any employer and shall be held for the exclusive purposes of providing
benefits to participants in the plan and their beneficiaries and defraying
reasonable expenses of administering the plan.
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ERISA section 404(a)(1)(A) provides, in part, that:
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A fiduciary shall discharge his [or her] duties solely in the interest of
the participants and their beneficiaries and (A) for the exclusive purpose
of (i) providing benefits to participants and their beneficiaries; and (ii)
defraying reasonable expenses of administering the plan. expenses of
administering the plan.
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It is the view of the Department that when the primary benefit requirement
is not met, then there would also be a violation of the "exclusive
purpose" and "solely in the interest" requirements of
sections 403 and 404 of ERISA.
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We hope this information is of assistance to you. Should you have any
questions regarding this matter, please do not hesitate to contact me.
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Sincerely,
Robert J. Doyle
Director of Regulations and Interpretations
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See Conference Report accompanying
ERISA, H.R. Rep. No. 1280, 93rd Cong., 2d Sess. 308 (1974).
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See S. Rep. No. 94-34, 94th Cong.,
1st Sess., 58-59 (1975).
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