ESOP Distribution & Taxation: How Does it Work? What Are the Rules?

One of an Employee Stock Ownership Plan’s (ESOP) distinctive advantages is its value as a qualified retirement plan. Questions about how ESOP share values are distributed and taxed are important not only to ESOP companies’ leadership teams, but also to employees.

As a defined contribution benefit plan, an ESOP can be an important part of an employee’s retirement savings. For this reason, it’s vital for employees to understand the basics about taxation of ESOP distributions.

What Employers & Administrators Need to Know About ESOP Distribution Timing

Clear and comprehensive plans for the timing of ESOP distributions are essential to effective ESOP management. A written distribution policy complements the ESOP plan documents, and helps ensure that all participants understand your plan’s current distribution process. 

While there are clear ESOP distribution rules that govern the timing of distributions for terminated employees with vested ESOP account balances, there are also exceptions, which allow some flexibility. At the same time, these exceptions could cause confusion if distribution plans are updated without clearly communicating changes to participants. 

Many ESOP employers have questions about requirements for the timing of distributions, especially for vested employees who are not retiring, disabled, or deceased. Here’s what you need to know about the requirements for ESOP distribution timing, and how to ensure your plan for distributions is not only in compliance with IRC regulations, but is also clear and easy to understand for plan participants.

2017 ESOP Benefit Payment Government Filings (IRS Forms 1099-R, 1096, 945)

If you paid any ESOP or other qualified retirement plan distribution of $10 or more last year you will have to prepare and file some government forms: Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

2016 ESOP Benefit Payment Government Filings (IRS Forms 1099-R, 1096, 945)

If you paid any ESOP or other qualified retirement plan distribution of $10 or more last year you will have to prepare and file some government forms: Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Qualified Charitable Distributions (QCD)

The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) was signed into law on December 18, 2015.  One item covered under the law was the permanent extension of the option to take a qualified charitable distribution (QCD).  This option, first available in 2006, allows IRA participants to exclude up to $100,000 from gross income for donations paid directly to a qualified charity from their IRA.

2015 ESOP Required Minimum Distributions (RMDs)

ESOPs and other qualified retirement plans require that plan participants begin taking a distribution of their retirement plan benefits after they reach a certain age. This distribution, also known as an IRS Required Minimum Distribution (RMD), is required for plan participants annually starting with the year that the participant reaches 70 ½, or if later, the year in which the participant retires. [If the account is an IRA or the account owner is a 5% owner sponsoring the plan, the RMD must begin upon attainment of 70 ½ .]

ESOP Diversification

The Tax Reform Act of 1986 established the ESOP diversification rules under IRC Section 401(a)(28) for qualified participants during the qualified election period.  ESOP diversification can be satisfied by a distribution, a transfer to another qualified plan, or offering three or more investment options in the ESOP (certain requirements apply).

2013 ESOP Required Minimum Distributions (RMDs)

ESOP Distribution Policy – Method

ESOP Distribution Policy - Form

Keep Your ESOP On Track and On Time
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