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Here is the first question on the Employee Stock Ownership Plan Review Worksheet:


1. Does the plan document formally designate the plan as an ESOP and provide that it will invest primarily in Qualifying Employer Securities ("QES")? Reg. 54.4975-11(a)(2) & 11(b).


Treasury Regulation Section 54.4975-11(a)(2) – 'ESOP' requirements – Designation as ESOP:
(2) Designation as ESOP. To be an ESOP, a plan must be formally designated as such in the plan document.

Treasury Regulation Section 54.4975-11(b) – 'ESOP' requirements – Plan designed to invest primarily in qualifying employer securities:

(b) Plan designed to invest primarily in qualifying employer securities. A plan constitutes an ESOP only if the plan specifically states that it is designed to invest primarily in qualifying employer securities. Thus, a stock bonus plan or a money purchase pension plan constituting an ESOP may invest part of its assets in other than qualifying employer securities. Such plan will be treated the same as other stock bonus plans or money purchase pension plans qualified under section 401a with respect to those investments.

The Employee Plans Compliance Unit (EPCU) has a current project on Qualifying Employer Securities:

This project focuses on plans that hold investments in employer securities to determine whether the plan's acquisition of employer securities satisfies the prohibited transaction exemption under Code section 4975(d)(13) which refers to ERISA section 408(e). In order NOT to be a prohibited transaction, employer securities must be acquired for adequate consideration without charging commissions, and the acquisition must comply with the requirements of ERISA sections 407(a) and (b). ERISA section 407(a)(2) provides that a plan may not acquire qualifying employer securities if immediately after such acquisition the aggregate fair market value of the qualifying employer securities and qualifying real property held by the plan exceeds 10% of the fair market value of the assets of the plan. ERISA section 407(b)(1) provides an exception for eligible individual account plans which include profit-sharing plans, 401(k) plans, ESOP plans, stock bonus plans and pre-ERISA money purchase plans holding employer securities. ERISA section 407(d)(3)(B) provides that an eligible individual account plan may acquire employee securities without regard to the 10% limit if the plan explicitly provides for the holding of employer securities. In other words, to be exempt from being a prohibited transaction, defined benefit plans and post-ERISA money purchase pension plans are never permitted to hold employer securities in excess of the 10% limit. Defined contribution plans, other than post-ERISA money purchase plans, may hold securities in excess of 10% the limit and be exempt if all other requirements are met.

Sponsors of plans holding employer securities that do not meet the prohibited transaction exemption are subject to an excise tax equal to 15% of the of the amount involved as stated in Code section 4975(a).

The IRS is using IRS Form 5500 data and sending compliance letters to plan sponsors who report Employer Securities with a plan type other than ESOP or stock bonus plan:

Compliance contact letters will be sent to a sample of plan sponsors who have filed Form 5500 returns that indicate on Schedule H or I that the plan has investments in Employer Securities that exceed 10% of Year End Total Assets. Our sample consists of sponsors of defined benefit plans and defined contribution plans other than ESOP or stock bonus plans. Our goal is to verify that plans meet the requirements that would exempt the acquisition of Employer Securities from being a prohibited transaction. The sponsors of plans that do not meet the requirements for exemption are subject to excise tax under 4975(a) and will be asked to File Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, and pay the excise tax for years not barred by the statute of limitations. Form 5330 returns that are filed for this purpose may be subject to examination.

The IRS will be looking for the above-mentioned plan language in their Plan Document Review. During an audit they may also check to see that any ESOP transactions satisfy the prohibited transaction exemption discussed in IRC Section 4975 – Tax on prohibited transactions.

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