In a previous blog post on the eligibility requirements for an ESOP, I discussed the age and service requirements that can be written into a plan document to enter the ESOP. It is quite common that plan documents will exclude the following individuals from participating in an ESOP, even though they’ve met the participation requirements allowed under IRC §410(a).
Employees leased by the ESOP company can be excluded from participating in the plan. The IRS defines an excludable leased employee under IRC §414(n). as a person who provides service to the company if:
(A) such services are provided pursuant to an agreement between the recipient and any other person (in this subsection referred to as the “leasing organization”),
(B) such person has performed such services for the recipient (or for the recipient and related persons) on a substantially full-time basis for a period of at least 1 year, and
(C) such services are performed under primary direction or control by the recipient.
Employees of Related Employers
Employees of related employers, also known as “affiliated employers”, can be excluded from participating in the ESOP. Related employers are companies that fall under a controlled group of corporations, or trades or businesses which are under common control. ESOPs normally exclude these employees, unless the related employer also adopts the plan.
Independent contractors are not common law employees, should not be reported on the company’s payroll, and their remuneration for services provided should be reported on an IRS Form 1099-MISC instead of an IRS Form W-2. The IRS even stated in a Technical Advice Memorandum, dated July 28, 1999, that independent contractors that are later reclassified as common law employees are also excludable under a plan.
Collective Bargained Employees
Collective bargained employees, also known as union employees, are commonly excluded from participating in ESOPs. The premise is the individuals that are part of the union have already negotiated their retirement benefits with employer, which in many times does not include the benefit of participating in the ESOP.
The IRS defines a nonresident alien as an individual who is not a U.S. citizen or U.S. national that does not meet either the “Green Card” test or the “Substantial Presence” test. To pass the green card test, you must be a Lawful Permanent Resident (an alien who has been granted the right by the USCIS to reside permanently in the United States and to work without restrictions in the United States) of the United States under the immigration laws of the United States. To pass the substantial presence test, you need to pass both the 31-day and 183-day tests.
ESOP plan documents can be written to limit participation in the plan that are not related to age and service. To the extent your ESOP excludes any of the individuals above and you have these types of individuals performing services for you, make sure your coverage testing is accurately reflecting the individuals that need to be included in the test.