Among the advantages of an employee stock ownership plan, the benefits to business owners and long-term cash and tax advantages to the company often receive most of the focus.
The Tax Reform Act of 1986 established the ESOP diversification rules under IRC Section 401(a)(28). As a result, the ESOP diversification provisions do not apply to employer securities held by an ESOP that were acquired before January 1, 1987.
We have recently discussed some of the statutory ESOP distribution rules.
- ESOP Distribution Timing: Death, Disability, Retirement
- ESOP Distribution Timing: Other Separations of Service
- ESOP Distribution Timing: Loan Exception
- ESOP Distribution Timing: Latest Commencement Date
- ESOP Distribution Timing: Required Minimum Distributions
- ESOP Distribution Timing: Qualified Domestic Relations Order (QDRO)
- ESOP Distribution Timing: Mandatory Distributions
- ESOP Distribution Timing: Diversification
Generally, an ESOP plan document will provide for the maximum statutory distribution rules mentioned above. In addition to the statutory requirements, the company also needs to manage cash flow and the annual employee benefit level to ensure that the company and ESOP remain sustainable in the long-term. To provide more flexibility, the company may implement a separate ESOP distribution policy. While some companies initially implement an informal unwritten distribution policy, especially in the early years of the ESOP, a best practice is to implement and maintain a separate written ESOP distribution policy document and make sure that it remains consistent with the way that distributions are processed.
We have been discussing the ESOP distribution timing rules and the distribution timing rules applicable to all qualified plans. The Internal Revenue Code provides that a qualified plan may process distributions of $5,000 or less without the written consent of the participant.
The ESOP distribution timing rules for terminations due to Death, Disability, and Retirement and Other Separations of Service are in addition to the distribution rules that apply to all qualified plan distribution rules. Generally speaking, the Internal Revenue Code does not allow the assignment of an account balance. It does make an exception for an alternate payee under a qualified domestic relations order (QDRO):
https://www.law.cornell.edu/uscode/text/26/409The ESOP distribution timing rules for terminations due to Death, Disability, and Retirement and Other Separations of Service are in addition to the distribution rules that apply to all qualified plan distribution rules. Yesterday we talked about the ESOP Latest Commencement Date. The provisions are another instance where the general qualified plan distribution rules in the Internal Revenue Code can supersede the ESOP distribution rules for Death, Disability, and Retirement, Other Separations of Service, and the ESOP Loan Exception, and ultimately impact the distribution commencement date. The Code also provides distribution timing provisions for deceased employees that supersede the ESOP Loan Exception.
We have discussed the ESOP distribution timing rules for terminations due to Death, Disability, and Retirement and Other Separations of Service. If there is an outstanding ESOP loan, the Internal Revenue Code allows payments to be deferred until the close of the plan year in which the loan is paid in full.
The Internal Revenue Code provides that ESOP distributions to participants that terminate as a result of death, disability, or retirement must begin no later than 1 year after the end of the plan year of the termination date. For example (assuming a 12/31 plan year end), if a participant terminates after meeting the retirement provisions of the plan on August 15, 2009, the participant must begin receiving payments after the December 31, 2009 allocation is completed (which should be sometime in 2010), and the payments must begin by December 31, 2010.
