Retire Ch 6 Stock Bonus & ESOP

Question 1

A stock bonus plan is a particular type of profit-sharing plan, so they share many characteristics.

a. True b. False

Answer 1

a. True

Question 2

A valuation of an employer’s securities is performed only at the creation of the stock bonus plan.

a. True b. False

Answer 2

b. False

Question 3

A stock bonus plan may require an employee to attain six years of service before considering the employee eligible.

a. True b. False

Answer 3

b. False

Question 4

Participants of a stock bonus plan must have pass through voting rights on the employer stock held by the plan.

a. True b. False

Answer 4

a. True

Question 5

The benefits provided to a plan participant under a top-heavy stock bonus plan must vest at least as rapidly as a 3-year cliff or 2-to-6-year graduated vesting schedule.

a. True b. False

Answer 5

a. True

Question 6

A principal disadvantage of a stock bonus plan is net unrealized appreciation.

a. True b. False

Answer 6

b. False

Question 7

Stock bonus plans may permit plan loans.

a. True b. False

Answer 7

a. True

Question 8

ESOPs for privately-held corporations are not required to provide full voting rights for shares held in the plan.

a. True b. False

Answer 8

a. True

Question 9

Employer contributions to an ESOP are tax deductible.

a. True b. False

Answer 9

a. True

Question 10

The put option protects the rank-and-file employees.

a. True b. False

Answer 10

a. True

Question 11

The trustee of an ESOP must act in the best interest of the plan participants and beneficiaries.

a. True b. False

Answer 11

a. True

Question 12

Which of the following are requirements for a qualified stock bonus plan?

1. Participants must have pass through voting rights for stock held by the plan.
2. Participants must have the right to demand employer securities at a distribution, even if the plan sponsor is a closely-held corporation.

a. 1 only.
b. 2 only.
c. Both1 and 2
d. Neither 1 nor 2

Answer 12

The correct answer is c.

Both statements are true.

1. Participants must have pass through voting rights for stock held by the plan.
2. Participants must have the right to demand employer securities at a distribution, even if the plan sponsor is a closely-held corporation

Question 13

Byron, age 60, is a participant in the stock bonus plan of Tally, Inc., a closely-held corporation. Byron received contributions in shares to the stock bonus plan and Tally, Inc. took income tax deductions as follows:
Year
Year 1 Year 2 Year 3 Year 4 Year 5
# of Shares
100 125 150 200 400
Value per Share (At Time of
Contribution) $10
$12 $13 $15 $18

Byron terminates employment and takes a distribution from the plan of 975 shares of Tally, Inc., having a fair value of $19,500. What are Byron’s tax consequences?

a. There are no immediate tax consequences because he has not sold the stock.
b. Byron has ordinary income of $14,650 at distribution.
c. Byron has net unrealized appreciation of $19,500 at distribution.
d. Byron has ordinary income of $19,500 at distribution.

Answer 13

b. Byron has ordinary income of $14,650 at distribution.

Byron’s ordinary income is exactly equal to Tally, Inc.’s deduction at the time of contribution, $14,650
(see chart below).

Byron’s net unrealized appreciation is $4,850 ($19,500 - $14,650) and will be taxed as long-term capital gains when the stock is sold.

Question 14

Brianna sells stock several years after she received it as a distribution from a qualified stock bonus plan. When the stock was distributed, she had a net unrealized appreciation of $7,500. Brianna also had ordinary income from the distribution of $29,000. The fair market value of the stock and the sale price at the time of sale was $81,000. How much of the sale price will be subject to long-term capital gain treatment?

a. $7,500.
b. $44,500.
c. $52,000.
d. $73,500.

Answer 14

The correct answer is c.

Sale Price - Adjusted Basis. $81,000 - $29,000 = $52,000 long-term capital gain.

The NUA of $7,500 is always LTCG.

The additional gain after distribution is LT because the stock was sold at least one year and one day after distribution

Question 15

Which of the following are costs of a stock bonus plan?

1. Periodic appraisal costs.
2. Periodic actuarial costs.

a. 1 only.
b. 2 only.
c. Both 1 and 2.
d. Neither 1 nor 2.

Answer 15

The correct answer is a.

Stock bonus plans require an independent appraisal of the stock value at contribution and distribution.

Stock bonus plans do not require actuarial work.

Question 16

Patrick and Kevin own Irisha Corporation and plan to retire. They would like to leave their assets to their children; therefore, they transfer 70 percent of the stock to a trust for the benefit of their 10 children pro rata. Patrick and Kevin then plan to sell the remaining Irisha shares to a qualified ESOP plan. Which of the following is correct?

1. The stock transfer to the ESOP is not a 50 percent transfer and therefore will not qualify for nonrecognition of capital gains.
2. Any transfer to an ESOP of less than 50 percent ownership may be subject to a minority discount on valuation.

a. 1 only.
b. 2 only.
c. Both 1 and 2.
d. Neither 1 nor 2.

Answer 16

The correct answer is b.

There must be a sale of at least 30% (not 50%) to the ESOP to qualify for nonrecognition of capital gain treatment.

In addition, any transfer that is less than 50% of the stock of the corporation might be subject to a minority discount on valuation.

Question 17

To qualify for nonrecognition of gain treatment, the following requirements apply:

The ESOP must own at least 30% of the corporation’s stock immediately after the sale.

The corporation that establishes the ESOP must have no class of stock outstanding that is tradable on an established securities market.

The seller and 25% shareholders in the corporation are precluded from receiving allocations of stock acquired by the ESOP through the rollover.

The stock sold to the ESOP must be common or convertible preferred stock and must have been owned by the seller for at least 3 years prior to the sale.

All of the above.

Answer 17

test
All of the above.

Rationale

All of the above apply to nonrecognition of gain treatment.

Question 18

Which of the following statements regarding leveraged ESOPs is correct?

When dealing with leveraged ESOPs, as a trust repays the bank loan, an appropriate allocation of funds are withdrawn from the holding account and allocated to the individual participant’s account.

When dealing with leveraged ESOPs, as a trust repays the bank loan, an appropriate allocation of shares are withdrawn from the individual participant’s account and allocated to the holding account.

When dealing with leveraged ESOPs, as a trust repays the bank loan, an appropriate allocation of shares are withdrawn from the holding account and allocated to the individual participant’s account.

None of the above.

Answer 18

When dealing with leveraged ESOPs, as a trust repays the bank loan, an appropriate allocation of shares are withdrawn from the holding account and allocated to the individual participant’s account.
Rationale

In a leveraged ESOP, a bank loan is used to provide the funds for the ESOP to purchase shares from the retiring owner in a lump sum transaction. The purchased shares are placed in a holding account and the appropriate amount of shares are removed from that account and allocated to the individual participant’s accounts each year.

Question 19

Davin sells stock six months after he received it as a distribution from a qualified stock bonus plan. When the stock was distributed, he had a net unrealized appreciation of $7,500. He also had ordinary income from the distribution of $29,000. The fair value of the stock at the time of sale was $81,000.

How much of the sale price will be subject to long-term capital gain treatment?

$7,500.
$44,500.
$52,000.
$73,500.

Answer 19

$7,500.

Rationale

Appreciation on the stock after the date of distribution is taxed as long-term capital or short-term capital gain, depending upon the holding period beginning at the date of distribution.

In this case, only the net unrealized appreciation of $7,500 is treated as long-term capital gain because the holding period for the sale was only six months.

The remaining $44,500 of gain is taxed as short-term capital gain.

Question 20

ESOP distributions can be made in installments:

1. No longer than 5 years under any scenario.
2. No longer than 5 years unless the account balance exceeds $1,380,000 for 2024, in which case an additional year is allowed for each $275,000 over $1,380,000 but not more than 5 additional years
3. In substantially equal payments.

3 only.
1 and 3.
2 and 3.
All of the above.

Answer 20

2 and 3.

Rationale

Statement 1 is false because the scenario with an excess of $1,380,000 allows an additional year for each $275,000 over $1,380,000.

Question 21

Which of the following are true as to leveraged ESOPs?

1. The corporation makes tax deductible contributions to the trust in the form of both principal and interest for the loan.
2. The trust purchases shares of corporate stock from the principal shareholder, but these shares are not pledged as security for the bank loan.
3. The corporation and the principal shareholder (seller) guarantee the loan and the corporation’s assets are pledged as collateral for the loan.
4. Prior to the allocation of the actual shares to the participant’s account within the trust, the pledged shares are held in a separate holding account and are referred to as unallocated.

1 and 3.
1, 2, and 3.
1, 3, and 4.
All of the above.

Answer 21

1, 3, and 4.
Rationale

Statement 2 is false because such shares are normally pledged as security for the bank loan.

Question 22

Rustin recently retired from Fox, Inc., a national plastics supplier. When Rustin retired his stock bonus plan had 10,000 shares of Fox, Inc. stock. Fox, Inc. took deductions equal to $20 per share for the contributions made on Rustin’s behalf. At retirement, Rustin took a lump-sum distribution of the employer stock. The fair market value of the stock at distribution was $35 per share. Six months after distribution, Rustin sold the stock for $40 per share.

What amount was subject to ordinary income on Rustin’s tax return at the date the stock was distributed?

$0.
$200,000.
$350,000.
$400,000

Answer 22

$200,000.
Rationale

Rustin will be subject to ordinary income at the date the stock is distributed equal to the value of the contributions made by the employer ($200,000)

Question 23

Rustin recently retired from Fox, Inc., a national plastics supplier. When Rustin retired his stock bonus plan had 10,000 shares of Fox, Inc. stock. Fox, Inc. took deductions equal to $20 per share for the contributions made on Rustin’s behalf. At retirement, Rustin took a lump-sum distribution of the employer stock. The fair market value of the stock at distribution was $35 per share. Six months after distribution, Rustin sold the stock for $40 per share.

How much gain was Rustin subject to at the date the stock was distributed?

$0.
$50,000 short-term capital gain.
$200,000 long-term capital gain.
$150,000 long-term capital gain and $5,000 short-term capital gain.

Answer 23

$0.
Rationale

Rustin will not have any capital gain until the stock is sold.

Question 24

Meb, the owner of Meb’s Hardware, is considering establishing a stock bonus plan. She recently talked with her advisor, Don T. Know. Don T. Know never studied when he took his certificate program, therefore he gave Meb incorrect information about stock bonus plans.

Which of the following statements given to Meb was correct?

Meb must establish a stock bonus plan for the current year no later than December 31 of the current year.

When the employee’s of Meb’s Hardware receive distributions of stock from the stock bonus plan, they will receive capital gain treatment on the distribution equal to the value of the stock as contributed by Meb’s Hardware.

A valuation of the stock of Meb’s Hardware is required when the stock bonus plan is established, but subsequent valuations are unnecessary.

Meb can require the employees to be age 21 and employed for two years before becoming eligible for the stock bonus plan.

Answer 24

Meb can require the employees to be age 21 and employed for two years before becoming eligible for the stock bonus plan.

Rationale

Meb can establish the stock bonus plan for the current year any time before the due date (plus extensions) of Meb’s Hardware’s tax return.

When the employees of Meb’s Hardware receive distributions of stock from the plan, the value of the distribution equal to the value at the date Meb contributed the stock will be ordinary income.

The net unrealized appreciation will be long-term capital gain at the time the stock is sold. Meb must have the stock valued at the date the plan is established and at the date of any distributions

Question 25

which of the following are requirements for a qualified stock bonus plan?

1. Participants must have pass through voting rights for stock held by the plan.
2. Participants must have the right to demand employer securities at a distribution, even if the plan sponsor is a closely-held corporation.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2

Answer 25

Both 1 and 2.

Rationale

Both statements are true

Question 26

Which phrase best completes the following sentence: “A repurchase option allows a terminating employee the choice to receive the cash equivalent of the employer’s stock if the stock is _____.”

Convertible.
Tradeable.
Not readily tradeable.
Not readily tradeable on an established market.

Answer 26

Not readily tradeable on an established market.

Rationale

This phrase is directly from IRC §409(h)(1).

Question 27

Rustin recently retired from Fox, Inc., a national plastics supplier. When Rustin retired his stock bonus plan had 10,000 shares of Fox, Inc. stock. Fox, Inc. took deductions equal to $20 per share for the contributions made on Rustin’s behalf. At retirement, Rustin took a lump-sum distribution of the employer stock. The fair market value of the stock at distribution was $35 per share. Six months after distribution, Rustin sold the stock for $40 per share.

What gain is Rustin subject to at the date the stock was sold?

$0.
$50,000 short-term capital gain.
$200,000 long-term capital gain.
$150,000 long-term capital gain and $50,000 short-term capital gain.

Answer 27

$150,000 long-term capital gain and $50,000 short-term capital gain.
Rationale

When Rustin sells the stock any appreciation after the employer’s contribution will be capital gain.
Rustin’s adjusted basis in the stock is the amount that was subjected to ordinary income ($200,000).

The appreciation before the date of distribution will be long- term capital gain ($150,000) while the taxation of the appreciation after the date of distribution will depend on the holding period.

Since Rustin only held the property for six months after the date of distribution, the $50,000 of appreciation after the date of distribution will be short-term capital gain.

Question 28

Patrick and Kevin own Irisha Corporation and plan to retire. They would like to leave their assets to their children; therefore, they transfer 70 percent of the stock to a trust for the benefit of their 10 children pro rata. Patrick and Kevin then plan to sell the remaining Irisha shares to a qualified ESOP plan.

Which of the following is correct?

1. The stock transfer to the ESOP is not a 50 percent transfer and therefore will not qualify for nonrecognition of capital gains.
2. Any transfer to an ESOP of less than 50 percent ownership may be subject to a minority discount on valuation.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2

Answer 28

2 only.
Rationale

There must be a sale of at least 30% (not 50%) to the ESOP to qualify for nonrecognition of capital gain treatment. In addition, any transfer that is less than 50% of the stock of the corporation might be subject to a minority discount on valuation.

Question 29

Which of the following statements are true regarding put options:

1. They are also referred to as “repurchase options” under ESOPs.
2. If the employer securities are not readily tradeable on an established market, the participant has the right to require that the employer repurchase the employer securities under a fair market valuation formula.
3. The put option is widely considered to be a substantial benefit to an employee-participant of an ESOP.
4. Rank-and-file employees at a closely held corporation are protected with the put option because the employee may force the corporation to “buy back” the stock at the fair market value when there otherwise would be no market for the stock.

1 and 4.
1, 2, and 3.
2, 3, and 4.
All of the above.

Answer 29

All of the above.
Rationale

All of the above statements are true

Question 30

Taylor, age 65, retires from Tickle Tile corporation and receives, from Tickle Tile’s stock bonus plan, 25,000 shares of Tickle Tile stock with a fair market value of $500,000. Taylor recognized $48,000 of ordinary income upon the distribution.

What is Taylor’s NUA immediately after the distribution?

$48,000.
$348,000.
$452,000.
$500,000.

Answer 30

$452,000.
Rationale

The NUA immediately after the distribution is $452,000 ($500,000 - $48,000).

Question 31

Which of the following are costs of a stock bonus plan?

1. Periodic appraisal costs
2. Periodic actuarial costs

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 31

1 only.
Rationale

Stock bonus plans require an independent appraisal of the stock value at contribution and distribution. Stock bonus plans do not require actuarial work.

Question 32

One of the disadvantages of an ESOP is that the stock is an undiversified investment portfolio.

Which of the following is correct?

1. An employee, age 55 or older, who has completed 10 years of participation in an ESOP may require that 100% of the account balance be diversified.
2. An employee who receives corporate stock as a distribution from an ESOP may enjoy net unrealized appreciation treatment at the time of distribution.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2

Answer 32

2 only.
Rationale

The first statement is incorrect because the percentage is 25% (increased to 50% for the final year of the election period), not 100%. The second statement is correct.

Question 33

Sam is a participant in RFK, Inc.’s ESOP. Sam has been a participant in the plan for eight years, and her account balance in the plan is $1,000,000 and is completely funded with employer securities. The plan defines the normal retirement age as 65 years old. Sam is 64 years old this year and would like to retire. Her advisor mentioned that she should have a more diversified portfolio. What, if anything, can she do to diversify her portfolio?

The only way Sam can diversify her portfolio is to take a distribution of the employer stock from the ESOP and reinvest the value in a diversified portfolio.

Sam can require the ESOP to diversify up to 25 percent of her portfolio.

Since Sam is in the final election year, she can require the ESOP to diversify 50 percent of her portfolio.

Sam can diversify 10 percent each year until the portfolio is completely diversified.

Answer 33

The only way Sam can diversify her portfolio is to take a distribution of the employer stock from the ESOP and reinvest the value in a diversified portfolio.

Rationale

Sam is not eligible to require the ESOP to diversify her portfolio because she has not been a plan participant for 10 years. T

hus, she must take distributions and sell the stock in order to diversify.

Question 34

Which of the following is (are) required for an investment advisor to be deemed a fiduciary under ERISA’s “renders investment advice” definition?

1. The investment advisor renders advice pursuant to an agreement.
2. The investment advisor is paid for the advice provided.
3. The investment advisor has influence approaching control over the plan’s investment decisions.
4. The investment advisor affirmatively elects to be a fiduciary.

2.
1 and 3.
1, 2, and 3.
1, 2, 3, and 4.

Answer 34

1, 2, and 3.
Rationale

If statements 1, 2, and 3 are true, the investment advisor is deemed a fiduciary under ERISA’s renders investment advice definition.

The advisor does not make an election to become a fiduciary or to avoid becoming a fiduciary, it is based on the advisor’s relationship with the plan

Question 35

The following definition applies to which of the following terms: “the corporation makes tax deductible contributions to a trust in the form of both principal and interest for the loan.”

A stock bonus plan.
An ESOP.
A leveraged ESOP.
A S corp ESOP

Answer 35

A leveraged ESOP.

Rationale

Only a leveraged ESOP will have a loan and thus, have principal and interest payments.

Question 36

Rustin recently retired from Fox, Inc., a national plastics supplier. When Rustin retired his stock bonus plan had 10,000 shares of Fox, Inc. stock. Fox, Inc. took deductions equal to $20 per share for the contributions made on Rustin’s behalf.

At retirement, Rustin took a lump-sum distribution of the employer stock. The fair market value of the stock at distribution was $35 per share.

Six months after distribution, Rustin sold the stock for $40 per share.

What amount was subject to ordinary income tax on Rustin’s tax return at the date Fox, Inc. contributed the stock to the plan?

$0.
$200,000.
$350,000.
$400,000.

Answer 36

0.
Rationale

Rustin will not be subject to ordinary income at the date contributions are made to the stock bonus plan.

Question 37

Angela owns NOCTM, Inc. and sells 100 percent of the corporate stock (all outstanding stock) on January 1, 2022 to an ESOP for $5,000,000. Her adjusted basis in the stock was $2,400,000.

Which of the following is correct?

1. If Angela reinvests the $5,000,000 in qualified domestic securities within 18 months, she has a carryover basis of $2,400,000 in the qualified domestic security portfolio and no current capital gain.
2. Angela has a long-term capital gain of $2,600,000 reduced by the 20 percent small business credit; therefore, his gain is $2,080,000 if she does not reinvest in qualified domestic securities within 18 months.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.
Confidence of your

Answer 37

Neither 1 nor 2.

Rationale

The $5,000,000 must be reinvested within 12 months and there is not a 20% small business credit.

In addition, to qualify for nonrecognition of gain treatment, the NOCTM, Inc. stock must have been owned by Angela for at least three years.

Question 38

Brianna sells stock several years after she received it as a distribution from a qualified stock bonus plan. When the stock was distributed, she had a net unrealized appreciation of $7,500. Brianna also had ordinary income from the distribution of $29,000. The fair market value of the stock and the sales price at the time of sale was $81,000.

How much of the sale price will be subject to long-term capital gain treatment?

$7,500.
$44,500.
$52,000.
$73,500.

Answer 38

$52,000.

Rationale

Sale Price - Adjusted Basis. $81,000 - $29,000 = $52,000 long-term capital gain.

The NUA of $7,500 is always LTCG. The additional gain after distribution is LT because the stock was sold at least one year and one day after distribution.

Question 39

Which of the following are false as to ESOPs?

1. An ESOP is controlled through a trust.
2. ESOPs provide corporate owners with a way to transfer ownership interests to their employees.
3. The trust of an ESOP is prohibited from borrowing money from a bank to purchase the employer stock.

3 only.
1 and 2.
2 and 3.
None of the above.

Answer 39

3 only.
Rationale

A key characteristic of the ESOP is that the trust may borrow money to purchase the employer stock.

Question 40

Bailey is 56 years old and obtained ten years of participation in the Blackwater ESOP in Year 1. Assume she elects to diversify 20% of her 200 shares during the 90-day period following Year 1.
Which of the following is correct?

If the total number of shares contributed as of the end of Year 3 was 300 shares, Bailey could diversify 75 shares during the 90-day period following Year 3.

Bailey can diversify additional shares, up to a cumulative total of 25%, anytime before the final year of the election period.

Bailey can diversify an additional 10 shares anytime before the final year of the election period.

During the 90-day period following Year 6, Bailey could diversify up to 250 shares, on a cumulative basis with prior diversification amounts, assuming a cumulative total of 500 shares had been contributed to her account as of the end of Year 6.

Answer 40

During the 90-day period following Year 6, Bailey could diversify up to 250 shares, on a cumulative basis with prior diversification amounts, assuming a cumulative total of 500 shares had been contributed to her account as of the end of Year 6.

Rationale

Option a is incorrect as she could not diversify 75 shares, rather, she could diversify that amount on a cumulative basis.

Options b and c are incorrect because it is only during the 90-days following the end of the year.

Option d is correct as she can diversify 50% for the final year.

Question 41

Byron, age 60, is a participant in the stock bonus plan of Tally, Inc., a closely held corporation. Byron received contributions in shares to the stock bonus plan and Tally, Inc. took income tax deductions as follows:

Byron terminates employment and takes a distribution from the plan of 975 shares of Tally, Inc., having a fair value of $19,500. What are Byron’s tax consequences?

There are no immediate tax consequences because he has not sold the stock.

Byron has ordinary income of $14,650 at distribution.

Byron has net unrealized appreciation of $19,500 at distribution.

Byron has ordinary income of $19,500 at distribution.

Answer 41

Byron has ordinary income of $14,650 at distribution.

Rationale

Byron ’s ordinary income is exactly equal to Tally, Inc.’s deduction at the time of contribution, $14,650 (see chart below).

Byron’s net unrealized appreciation is $4,850 ($19,500 - $14,650) and will be taxed as long-term capital gains when the stock is sold.

Question 42

Bobby owns Advertising Solutions, Inc. (ASI) and sells 100% of the company stock on July 1 of the current year to an ESOP for $3,000,000. Bobby had an adjusted basis in the ASI stock of $450,000. If Bobby reinvests in qualified replacement securities before the end of the current year, which of the following statements is true?

Bobby will not recognize long term capital gain or ordinary income in the current year.

Bobby must recognize $2,550,000 of long term capital gain in the current year.

Bobby must recognize $450,000 of ordinary income in the current year.

If Bobby dies before selling the qualified replacement securities, his heirs will have an adjusted taxable basis in the qualified replacement securities of $450,000, Bobby’s carryover adjusted basis.

Answer 42

The correct answer is A.

A major advantage for an ESOP is the ability of the owner to diversify his interest in a closely held corporation.

In this case, if Bobby reinvests in qualified replacement securities within 12 months of the sale to the ESOP, he will not recognize capital gain or ordinary income on the sale to the ESOP.

If Bobby dies the heirs will receive the secu­rities with an adjusted taxable basis equal to the FMV at Bobby’s date of death or the alternate valuation date.