House Ways and Means Passes Retirement Reform Bill

Stand-Alone ESOPs Exempted; IRS Blocked from Implementing Withholding Taxes on ISOs and ESPPs

The House Ways and Means Committee has voted 36-2 to pass H.R. 3669, an amended version of legislation introduced by Rob Portman (R-OH) and Benjamin Cardin (D-MD) to reform 401(k) plans. Portman and Cardin were the authors of last year's sweeping reform of retirement law. The proposal exempts stand-alone ESOPs, defined as ESOPs not formally or operationally linked to a 401(k) plan. This would include ESOPs not part of a 401(k) plan but in which either employees can make deferrals of their pay into the plan or where contributions to the ESOP are designated as matches to employee deferrals in a 401(k) plan. Plans in privately held companies are also excluded. The principal provisions affecting retirement plans are:

• After three years of service, employees could sell employer stock they have received as matching contributions, and after five years could sell stock received as non-elective contributions. Employees could immediately diversify their own deferrals.
• Employers would have to notify employees at least 30 days in advance of any significant period in which employees will be unable to trade.
• Employees would receive periodic notices on the advantages of diversifying their accounts. Companies failing to do so would be fined.
• There would be a new tax deduction for employees to pay for the cost of retirement planning services.

Stock Option/ESPP Surprise

In a surprising move, the committee went along with industry proposals to prohibit the IRS from imposing planned withholding requirements for ISOs and ESPPs. The IRS has proposed regulations, effective 2003, that would require employers to withhold payroll (but not income) taxes on stock option exercises or purchases under incentive stock option (ISO) plans or employee stock purchase plans (ESPPs). Employer groups have argued the withholding would be at best very burdensome and at worst impractical. They have also noted that the tax would be imposed even though employees might later sell the stock at a loss or might exercise their options when no longer on the payroll. Some employers have said they might stop offering some of these plans if they had to withhold.

Outlook

The strong bipartisan support for the bill suggests its chances in the whole House are very good. Ways and Means shares jurisdiction on this with the Education and the Workforce Committee, which still could report its own bill. Industry groups oppose the bill, but are much happier with it than with prior proposals. In the Senate, somewhat stronger legislation is likely. The withholding rule change has not yet been broached.