Who must be included in the ESOP? What are the minimum ESOP participation rules?

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The rules for participation in an ESOP are the same as for other qualified employee benefit plans (pensions, profit sharing, etc.). The rules provide several tests to assure plans meet minimum anti-discrimination requirements. Virtually all ESOP companies, however, cover at least all employees with 1000 hours of service or more in a year who are 21 years of age or older and have at least one year of service. Employees covered by a collective bargaining agreement can be excluded from coverage, provided the company bargains in good faith about all retirement benefits. These are minimum requirements; companies can include more employees (such as including part-time people or more recent hires).The law does provide some additional exceptions. For instance, the ESOP can include only employees in a separate line of business, such as a division or subsidiary, that has 50 or more employees. This will not apply, however, if the intent is to get around the coverage rules. For instance, a plan could not just cover a division set up of management people and exclude a division that just has non-management employees.An alternative approach provides three tests for coverage. To use this approach a company applies percentage tests to at least a minimum employee group. This group must include all employees 21 or older who have completed at least 1,000 hours of service in a plan year, but can exclude nonresident aliens, employees in a separate line of business with 50 or more employees, and employees covered by a collective bargaining agreement. After the exceptions have been taken, the tests can be met if:1.        At least 70% of non-highly compensated employees are covered,2.        The percentage of non-highly compensated employees who are covered is at least 70% of the percentage of highly compensated covered, or3.        There is a classification system that does not discriminate in favor of highly compensated employees and the average benefit percentage (generally, the percentage contributed to the plan) for the covered non-highly compensated group is at least 70% of that contributed to the covered highly compensated group.Although these alternative tests are available, they are very, very rarely used in ESOPs. The kind of exclusion the rules provide is both contrary to the spirit most ESOP companies are trying to set up and may cause practical problems, most importantly that if the eligible payroll base drops too low, the company may not have enough eligible payroll against which to make contributions and/or annual additions.For a detailed description of the rules and uses for ESOPs, see Understanding ESOPs.