Employee stock ownership plans determination letter application review process

An employee stock ownership plan (ESOP) is an individually designed stock bonus plan, which is qualified under Internal Revenue Code Section 401(a), or a stock bonus and a money purchase plan both of which are qualified under IRC Section 401(a), and which are designed to invest primarily in qualifying employer securities. An ESOP may form a portion of a plan, the balance of which includes a tax-qualified pension, profit-sharing, or stock bonus plan which isn't an ESOP. ESOPs generally have participation, vesting and allocation features common to all qualified plans. ESOPs are subject to the distribution provisions of IRC Section 401(a)(14), but must also comply with the distribution and payment requirements of IRC Section 409(o).

ESOPs generally are also required to:

• provide participants with the right to demand distributions in the form of employer securities;
• prohibit allocations of certain securities acquired in a sale to which IRC Section 1042 applies;
• prohibit allocations of securities in an S corporation under certain circumstances; and
• provide certain voting rights if the employer has a registration-type class of securities.

In addition, ESOPs may have distinctive features, for example:

• plan provisions related to the debt-financed acquisition of stock to generate cash for the employer’s corporation; and
• plan provisions related to a C corporation plan sponsor’s ability to deduct dividends paid on stock held by the ESOP.

In 2009 and 2010, Employee Plans issued a series of Responses to Technical Assistance Requests (memoranda), which addressed certain ESOP issues.

Review process

A team of ESOP specialists reviews all ESOP determination letter applications to ensure that the plan document meets applicable requirements under the Internal Revenue Code and related regulations. This article provides information on:

• How we review ESOP determination letter applications
• How to check on the status of your letter
• When you must provide documentation for your controlled group election
• Plan provisions permitting transfers from non-ESOP plans

How we review ESOP determination letter applications

ESOP determination letter applications are reviewed in a 2-step process.

Step 1 – Procedural review

The application is assigned to an ESOP specialist, who reviews whether it:

• has a prior determination letter application or letter;
• was eligible to submit for a determination letter;
• enclosed:
  • the correct determination letter application user fee PDF (or whether the plan sponsor qualifies for a user fee exemption),
  • all required forms (completed, signed and dated), and
  • the plan document and amendments.

  Step 2 – Technical review

  During this step, the same specialist reviews the plan document using:

  • the applicable Cumulative List or Required Amendments List;
  • the memoranda;
  • a standardized ESOP checksheet (rev. 04/14) PDF ; and
  • feedback from the Quality Assurance group, if applicable.

  If there aren’t any technical issues and the plan document fully complies with all applicable legal requirements under the Code and related regulations, the specialist will issue a favorable determination letter and close the application.

  Coordinating submissions of multiple ESOPs

  Practitioners who have submitted applications for multiple ESOPs, and who receive a letter from a determination specialist requesting plan amendments to a particular plan, may determine the applicability of that request to all other plans filed by the practitioner's firm and submit a single response that would apply to some or all of the amendments to the firm’s pending ESOP Form 5300 applications. Include the letter from the determination specialist requesting the amendment(s) and provide a separate copy of the amendment to each affected plan, identifying the plans to which the proposed amendments apply.

  Check the status of your letter

  You can check the status of your pending determination letter. This page is updated every few weeks to list the postmark dates for each type of application that are currently being reviewed. ESOP applications are listed separately from other Form 5300 and Form 5310 applications.

  Plans with language permitting transfers from non-ESOP plans

  Plan sponsors may transfer S corporation stock to a non-ESOP plan or non-ESOP portion of a plan to prevent a nonallocation year under IRC Section 409(p). In general, a nonallocation year is any ESOP plan year during which:

  • the plan holds stock in an S corporation, and
  • disqualified persons own at least 50% of the number of shares of stock in the S corporation.

  We're studying whether it is permissible under the Code and related regulations for an ESOP to provide that the plan sponsor may transfer S corporation stock from a non-ESOP plan (or non-ESOP portion of a plan) back to the ESOP (or ESOP portion of the plan) if a nonallocation year wouldn't occur. If the plan contains any such language, we recommend that it be removed from the plan so that we can keep processing the determination letter application; otherwise, the application will be put into suspense until this issue is resolved.

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