Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

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What is a letter of determination and when must an application for it be filed?

A letter of determination is a letter from the Internal Revenue Service indicating that they have inspected your plan documents and provisionally found that in form, and with regard to the operational matters specifically disclosed and analyzed during the process, the plan meets the requirements of the Internal Revenue Code to be qualified and exempt from tax. The letter is not a guarantee that the IRS will not change its mind about the plan or that the operation of the plan will not subsequently cause a violation. If a company has filed for and received a letter, however, it has a much stronger case should there be a question about plan provisions. You do not have to wait to get a letter before starting a plan.

Normally, the request would be filed when the ESOP is put in place or when the plan documents are completed. Also, a letter of determination is needed when there are amendments required to comply with new laws or regulations. In order to have a letter retroactive to the first day a plan is in effect, it must be applied for no later than the tax filing deadline for the first year for which the plan is effective. The IRS may take several months or more to respond to the request. The company does not have to wait for a favorable ruling to proceed. Usually, if a letter of determination is not granted, the applicant can amend the plan to correct the flaw without incurring penalties.

In 2006, the IRS issued new rules requiring that companies file a new letter of determination every five years, based on a five-year reporting cycle determined by employer identification numbers. For years before January 2017, companies are required to file for a new letter of exemption every five years based on a cycle that is assigned. If a company neglects to do this, it should contact the IRS and let them know what happened. If can file for a voluntary correction procedure. If the plan was amended properly to reflect any new laws, and is operating in compliance with all current laws, the process should be relatively painless.

For years after January 1, 2017, the IRS will eliminate the five-year remedial amendment cycles. This means sponsors can only now submit letters of determination requests for initial plans and plan terminations. Because of the timing of the change, the IRS will continue accepting applications for Cycle A plans through Jan. 31, 2017, which is the end of that cycle's submission period.

For details, see IRS Announcement 2015-19.

Link to this FAQ Topic: Governance, Fiduciaries & Compliance