Senate Passes Retirement Reform As Part of Tax Bill

The Senate-passed tax cut legislation has incorporated a revised version of the Comprehensive Retirement Income Security Act (S. 742) as part of its income tax reduction legislation. The tax bill incorporates just about all of S. 742's provisions, but some of them are phased in over longer periods of time than the House-passed version or the version that came out of the Senate Finance Committee.

On the ESOP front, the bill would make it much more difficult for sham S corporation ESOP transactions to occur. The complicated provision essentially provides severe tax disincentives to use an ESOP in an S corporation in such a way that only a few employees actually benefit from the plan. Under the proposal, a 50% corporate excise tax and individual income tax would kick in on allocations made to "disqualified individuals" in the plan, defined as those owning either more than 10% individually or 20% when considering attribution rules. Ownership includes synthetic equity (options, warrants, etc.), direct ownership, and ownership in the ESOP. In the Senate bill, for ESOPs set up after July 11, 2000, the effective date is the end of the plan year in which the plan was set up. The House bill's comparable provision is that the effective date for plans set up after March 14, 2001 is the end of the plan year in which the plan was set up. For plans set up prior to that, the Senate bill's effective date is December 31, 2002; the House bill is December 31, 2004.

Both bills also would allow employees to reinvest dividends on ESOP shares back into the ESOP to buy more company stock on a pre-tax basis. The Senate version of the bill, however, phases in the dividend reinvestment provision at 25 cents per dollar reinvested from 2002 through 2004, 50 cents from 2005 through 2007, 75 cents from 2008 through 2010, and 100% after 2010. The House bill provides a full deduction for each dividend dollar reinvested.

In addition, changes to contribution limits and other rules governing defined contribution plans would make it easier to combine an ESOP with a 401(k) plan. The major provisions that affect employee ownership are listed below:

• The annual limit on annual additions would be raised from $35,000 to $40,000 per year and thereafter indexed for inflation in $1,000 increments (both Houses).
• The current limit on salary defined as eligible pay for making contribution to employee accounts would be raised from its current $150,000 (in 1993 dollars) to $200,000 (in July, 2000 dollars), but the Senate bill would raise the limit in $5,000 increments, whereas the House bill makes the change immediately.
• The maximum amount an individual can defer to a 401(k) plan is increased to $11,000 in 2002 then in $500 increments until 2010, when it will be indexed for inflation, rounding up to the closest $500 increment annually. Individuals 50 and over could add another $5,000 annually to this amount. The House version would increase the limit in $1,000 increments.
• Elective deferrals no longer reduce the employer's limit on what can be contributed to a defined contribution pan, or combination of plans (both Houses).
• The current limit on annual additions to employee accounts in defined contribution plans of 25% of pay per year is increased to 100% per year in the House version; in the Senate version, the limits go to 50% from 2002 through 2010, then go to 100%.
• The current limit of 15% of eligible pay that can be contributed to plan participants in non-leveraged ESOPs and other defined contribution plans will be increased to 20% of pay in the House version and 25% in the Senate version. If combined with a money purchase plan under current law, that means a non-leveraged plan could contribute as much as 30% of pay.
• The definition of employees in the "top-heavy" group is simplified in both versions of the bill.

For a summary of the law's retirement provisions, go to this link.