ESOP Regulatory Rulings 1990-2024
Categorizes and summarizes IRS and DOL rulings and regulations on ESOPs and related plans.
By Corey Rosen
Format
Description
This 44-page publication provides practitioners and other interested people with a summary of rulings and regulations on ESOPs and related plans. It includes guidance from the IRS and the DOL through IRS private letter rulings (PLRs), DOL advisory opinions, DOL field assistance bulletins, IRS Technical Assistance Memoranda, and similar pronouncements such as the "ESOP Cadre" guidance. Regulations can be very lengthy, and here we do not summarize them in detail but rather highlight the key issues and rules. The original version of this publication appeared in 2011 and is updated yearly. The 2024 edition adds two items: (1) new guidance issued by the IRS, DOL, and Pension Benefit Guarantee Corporation affecting who must have an annual plan audit effective for plan years starting in 2023 onward, and (2) Rev. Rul. 2003-27 from 2003, requiring the basis of S corporation ESOP shares to be adjusted for net unrealized appreciation calculations.
Table of Contents
Introduction
Accounting
Banks and Thrift Institutions
Contributions
Definition of Employer Securities
Distribution Requirements, Procedures, and Taxation
Distribution Taxation
Diversification
Dividends
Eligibility, Vesting, and Allocation Issues
ESOP/401(k) Plans
Federal Contractor Reimbursement
Fiduciary Issues
International ESOPs
Leveraged ESOP Issues
Limited Liability Companies
Mergers and Reorganizations
PAYSOPs (Payroll-Based Stock Ownership Plans)
Plan Administration
Plan-to-Plan Transfers
Pension Plan Reversions
S Corporation ESOP Anti-Abuse Rules
S Corporation Issues Other Than Anti-Abuse Rules
Sale of Stock to an ESOP (Including 1042 Issues)
Securities Law
Appendix: Key Issues in DOL Settlement Agreements
Excerpts
From "Plan Administration"
IRS Issues New Guidance to Voluntary Correction Program: Revenue Procedure 2021-30 lays out a number of changes to the Voluntary Correction Procedure process for the correction of plan qualification errors. The new procedures generally will make it easier to use the process. Some of the changes affect only 401(k) plans, but others affect ESOPs as well.
When a company makes errors in its plan design or operations that could cause the plan to become disqualified, such as not making distributions on time or not crediting a qualified employee properly for a year of service, companies may be able to correct the error voluntarily. The Self-Correction Program (SCP) does not require filing with the IRS, and corrections can be made at any time. Whether an error is eligible for self-correction depends on the type and severity of the problem. The Audit Closing Agreement Program (Audit CAP) is used when the IRS finds an error. The Voluntary Correction Program (VCP) is used when the company needs to file its compliance actions with the IRS. Under prior rules, the self-correction time limit for errors that do not qualify as insignificant was two years. The new rules extend the limit to three years.
A second change concerns retroactive changes to plan documents. Plan sponsors were able to make retroactive changes to documents only if the changes improved benefit rights or plan features for participants, the change was permitted under IRS rules, and the benefit or feature improvement was available to all employees. Meeting all three criteria proved to be a difficult test because some changes were designed to fix a problem that applied only to certain employees. The new procedures eliminate the all-employees test.
A third change allows participants who receive an overpayment of benefits to repay them in a lump sum or installments.
Finally, the new rules end the ability of a plan sponsor to get feedback anonymously on proposed plan changes or corrections under voluntary correction programs before they are made. While this process has always been time-consuming and uncertain, from January 1, 2022, feedback can only be given at the IRS’s discretion. Companies may not consider this to be a useful option.
EPCRS guidance. SECURE 2.0 expanded the application of the Employee Plans Compliance Resolution System (EPCRS), which allows companies to voluntarily correct certain errors. The current guidance on how to use the system is in Revenue Procedure 2021-30. SECURE 2.0 required that the IRS develop new guidance within two years of the date of the bill’s enactment. In IRS Notice 2023-43 (May 23, 2023), the IRS issued advance guidance on the new provision that companies can use (pending the final rules) and also solicited comments on the proposal.
From "Sale of Stock to an ESOP (Including 1042 Issues)"
Substantial compliance. PLRs 199927003, 199934006, 199934007, 199934008, 199944009, 199944025, 9821022, 9852004, 9846015, 9735046, 9619065, 9550014, 9438016, 9429017, PLR 9028082, and 201144040: This series of PLRs all ruled that substantial taxpayer compliance with the requirements of Section 1042 were sufficient qualify for tax-deferral of capital gains even though the replacement property section had not been properly notarized.
Convertible preferred. PLR 9836022: Ruled that convertible preferred stock received in a recapitalization immediately before a sale to an ESOP would qualify as common stock and thus be an eligible employer security under ESOP requirements. Moreover, the stock would not be “Section 306” stock subject to ordinary income taxation immediately upon the exchange.
Stock options. PLR 9830028: Ruled that the sale of stock acquired pursuant to the exercise of nonstatutory stock options acquired before Section 83 of the Code was enacted in 1969 would be eligible for tax deferral treatment under Section 1042 of the Code. Note that this is an unusual case—options acquired after that date are not eligible for tax deferral.
Transfer to family limited partnership. PLR 9846005: Ruled that shares transferred to a family limited partnership and then sold to an ESOP were eligible for tax deferral treatment under Section 1042 of the Code, and that the three-year holding period requirement tacked on the years the shares were held by the owners who made the transfer.