Sinkorswim

01/12/02 - More On Company Stock and 401K Plans

By: Frank Armstrong, CFP, AIF

If we accept the spirit and intent of ERISA, contributions of company stock to a qualified plan ought to be prohibited. But, our current tax laws and accounting conventions actually encourage this naughtiness.

The correct amount of employer stock for an employee to own is very close to zero. Certainly, it is unwise to hold more than the stock's weighting in the Wilshire 5000. This includes both personal accounts and qualified pension accounts. So, it's impossible to sustain the argument that from the employee's point of view he should prefer a contribution of company stock to his 401(k) account over a straight cash contribution.

If we accept the spirit and intent of ERISA, contributions of company stock ought to be prohibited. But, our current tax laws and accounting conventions actually encourage this naughtiness. Given the strange incentives (read that as big glaring ugly loopholes) built into the system, a company would be foolish not to contribute stock in lieu of cash.

Let's look at this a little closer:

• 1. Contributions of company stock do not affect the company's cash flow. Cash flow is a prime measurement of a company's health, and treasured by some accountants and analysts above even profits. So, a company contributing stock instead of cash looks better to Wall Street and investors than one that contributes cash.
• 2. Contributions of company stock are not recorded as expense on the company's income statement. So, profits will be overstated and losses understated relative to a company that contributes cash. Why should a company be penalized for doing the right thing by its employees? Perhaps no good deed goes unpunished.
• 3. Contributions of company stock are fully deductible for tax purposes. Now, wait! It's not an expense, it's only funny money, but it's fully deductible? What am I missing here? Perhaps only a good lobbyist?

Perhaps you don't share my concern for employees, and the almost sacred nature or retirement plans. OK. I can deal with that. But, should we encourage such a strange financial and accounting outcome as a matter of public policy?

Do we not have just the smallest issue with transparency here? Two companies with the same financial position should not have such widely different accounting outcomes. Otherwise, what good are financial statements?

And what about tax fairness? Should a company really get a tax deduction for a funny money contribution? The Boxer Bill, currently winding it's tortured way through Congress would limit the deduction to 50%, but why should a company get anything?

It's time to end the tax deduction for a contribution of company stock to qualified retirement plans. It's bad for employees, bad public policy, bad accounting, and bad tax policy.

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