Included in the Consolidated Appropriations Act of 2023 and passed with broad bipartisan support, SECURE Act 2.0 became law on December 29, 2022. The bill brought a raft of changes to retirement and qualified plan-related laws with an eye toward improving Americans’ retirement readiness.
With employer and employee tax credits, plan-linked emergency savings, expanded coverage for part-time employees, auto-enrollment and escalation, increased catch-up contribution limits, changes to required minimum distribution rules … SECURE 2.0 has an extraordinarily expansive reach.
In fact, SECURE 2.0 also brings changes for employee stock ownership plans (ESOPs):
- The Worker Opportunity, Readiness, and Knowledge (WORK) Act calls for the Department of Labor (DOL) to establish an Employee Ownership Initiative, including formal guidance for the initiative
- Directs the DOL to provide formal guidance on valuation standards for determining fair market value
- Extends the 10% tax deferral from Section 1042 election to certain sales to S corporation ESOPs
- Changes the definition of “publicly traded” in IRC Section 401(a)(35) for purposes related to ESOP account diversification
Why is it a big deal? This is bipartisan legislation that promotes, rather than discourages, employee ownership, and has the potential to extend the benefits of employee ownership to many more American workers.
The WORK Act & Employee Ownership Initiative
SECURE 2.0 directs the DOL to support new and existing state-level employee ownership programs, with $50 million in appropriations over five years to help fund:
- Grants to improve education and outreach
- Data collection and analysis about state programs
- Development and dissemination of employee ownership best practices
The Employee Ownership Initiative is required to be established within 180 days of enactment of the omnibus bill. It creates opportunities for outreach and training in financial education, open-book management, and other practices that nurture ownership culture.
ESOP Standards for Fair Market Valuation
The WORK Act also directs DOL to establish “standards and procedures to establish good faith market value for shares of a business to be acquired” by an ESOP. Section 408(e) of the Employee Retirement Income Security Act of 1974 (ERISA) exempts an ESOP’s purchase of the sponsoring company’s stock only if the ESOP pays no more than fair market value for it.
The ESOP community has long voiced a need for formal guidance on ESOP valuation procedures and practices.
Section 1042 Deferral Election is Now an Option for Sellers to S Corp ESOPs
Before SECURE Act 2.0, rules allowed only owners of stock in non-publicly traded C corporations to defer capital gains tax on up to 100% of proceeds from the sale to an ESOP, provided certain requirements are met.
Sales to ESOPs after December 31, 2027 will allow owners of non-publicly traded S corporations to defer capital gains tax on up to 10% of proceeds from such a sale.
A Revised Definition of “Publicly Traded” Securities
For plan years starting after December 31, 2027, employer securities will be treated as “publicly traded” for diversification purposes under Section 401(a)(35)(G)(v) if they:
- Are subject to priced quotations by at least four dealers on a Securities and Exchange Commission-regulated interdealer quotation system
- Are NOT penny stocks
- NOT issued by a shell company, a blank check company, or a company subject to Are bankruptcy proceedings
- Have a public float with fair market value of at least $1 million and which constitutes at least 10% of outstanding shares
Domestic corporations with securities meeting the requirements will be required to publish audited financial statements at least annually to be considered “publicly traded.” Foreign corporations must meet additional requirements. The goal of this change is to make it easier for companies to offer ESOPs to their U.S. employees.
What’s Next for ESOPs?
We’ll be watching for DOL’s guidance, as well as the establishment of the new Employee Ownership Initiative and Congress’s funding of the initiative, in the months to come.
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