This publication provides practitioners and other interested people with a summary of rulings and regulations on ESOPs and related plans. It includes guidance from the IRS and the DOL through IRS private letter rulings (PLRs), DOL advisory opinions, DOL field assistance bulletins, IRS Technical Assistance Memoranda, and similar pronouncements such as the "ESOP Cadre" guidance. Regulations can be very lengthy, and here we do not summarize them in detail but rather highlight the key issues and rules. The original version of this publication appeared in 2011 and is updated yearly. For the 2021 edition, there are three new items, one on guidance on annuity distribution requirements, one on cybersecurity, and one on the investment prudence rules relating to non-pecuniary factors such as environmental, social, and corporate governance (ESG) investing.
You also may be interested in our companion publication ESOP and 401(k) Plan Employer Stock Litigation Review 1990-2021, which categorizes court decisions in ESOP and 401(k) company stock cases from 1990 through mid-2021 and provides brief summaries for the ESOP-related decisions and, starting in 2010, most 401(k) cases.
Table of Contents
Banks and Thrift Institutions
Definition of Employer Securities
Distribution Requirements, Procedures, and Taxation
Eligibility, Vesting, and Allocation Issues
Federal Contractor Reimbursement
Leveraged ESOP Issues
Limited Liability Companies
Mergers and Reorganizations
PAYSOPs (Payroll-Based Stock Ownership Plans)
Pension Plan Reversions
S ESOP Corporation Anti-Abuse Rules
S Corporation Issues Other Than Anti-Abuse Rules
Sale of Stock to an ESOP (Including 1042 Issues)
Appendix: Key Issues in DOL Settlement Agreements in GreatBanc, First Bankers Trust, James Joyner, Alpha Investment, Lubbock National Bank, and Farmers National Bank Cases
From "S Corporation Issues Other Than Anti-Abuse Rules"
Floor price agreements. PLR 200914019 and PLR 200827008: The IRS confirmed its position that an S corporation ESOP sponsor may provide a guaranteed or floor price arrangement for ESOP participants without violating the "one class of stock" restriction generally applicable to S corporations.
Temporary ownership of shares. IRS Revenue Procedure 2003-23. Provided that the temporary holding of company stock by an IRA trust established to roll over a distribution does not violate S corporation rules by creating an impermissible shareholder.
Permitted year. IRS Rev. Proc. 2002-38. Provided that the taxable year of an ESOP S corporation must be a "permitted" year, meaning a calendar year except in very limited circumstances. Fiscal year S corporations where the ESOP owns a majority, but not all, of the capital stock of the corporation may not use the exception that permits the corporation to retain the taxable year of its sole owner (i.e., the ESOP). It appears these corporations must now change their fiscal years to the calendar year unless they petition the IRS and receive approval to retain their fiscal years. Companies that retained their fiscal year and did not use the automatic approval process may be eligible for grandfathering under the ruling.
Temporary ownership of shares. PLR 200122034: Ruled that transient ownership of shares by an ESOP participant receiving a distribution from an S ESOP and rolling them into an IRA will not cause a violation of the prohibited ownership rules for S corporations.
Earnings on unallocated shares. PLR 200014043: Ruled earnings on unallocated shares can be used to repay an ESOP loan.
Right to elect benefit form. IRS Final Regulations (T.D. 8806): Final regulations ruling that the amendment of an S corporation ESOP to eliminate participants' right to elect benefit distributions in the form of company stock does not violate the protected benefit rules under Section 411(d)(6).
Reconversion. PLR 199952072: Ruled that a company that converts from S to C status in order for sellers to an ESOP to take advantage of Section 1042 tax deferral treatment cannot then reconvert to S status before five years have passed. The ruling also noted that the company could not become a qualifying S corporation subsidiary if acquired by an S corporation within five years.
Repayment of loan. PLR 199938052: Ruled that earnings on allocated shares in an S corporation cannot be used to repay an ESOP loan, but earnings on unallocated shares can (this was later changed by legislation; current law allows earnings on either kinds of shares to be used to repay a loan).
Repayment of loan. PLR 199948038: In a second ruling on the issue of using earnings on ESOP shares to repay an S ESOP corporation loan, the IRS ruled that earnings on unallocated shares could be used. This ruling did not address the issue of earnings on allocated shares.
Tacking period. PLR 200003014: Ruled that company stock will constitute "qualified securities" under Section 1042 and that the selling shareholders' holding period for purposes of the three-year holding period requirement prior to sale to an ESOP will include the period during which the company was an S corporation.
Distributions in S Corporations Are Not Annual Additions: In PLR201424030 (March 20, 2014), the IRS ruled that distributions in a 100% ESOP-owned S corporation are not annual additions. The company will allocate the distributions based on relative share balance. The company said that its earnings exceeded its cash needs.