Many public companies allow their employees to invest a portion of their retirement plan balances in company stock. By making a company stock fund an available investment in a 401(k) plan, employees may share the potential gains otherwise reserved for stockholders. If the stock fund is structured to meet the legal requirements of an employee stock ownership plan (an ESOP), the company can get an extra benefit—dividends paid on public company shares held by an ESOP can be deducted by the company.
ESOPs are subject to various compliance requirements that do not apply to other types of retirement plans. One such requirement is that a participant’s ESOP account must be subject to diversification (i.e., the participant must be given the opportunity to cash-in his or her shares and invest in something other than company stock). Prior to 2007, diversification was only required on a portion of a participant’s ESOP account, and then only after the participant satisfied certain age and service requirements. However, beginning in 2007, for public company ESOPs that held employee contributions or were part of a larger 401(k) plan (often called a KSOP), diversification from company stock was required to be available much sooner. Since 2007, diversification from those ESOPs must be permitted immediately for employee contributions, while diversification of company contributions must be available once the employee has accrued at least three years of service.
In April, 2013, the IRS issued Notice 2013-17 (the Notice), which makes clear that retaining the pre-2007 diversification provisions in an ESOP subject to the new diversification requirements can cause a violation of applicable rules and may result in disqualification of the ESOP. To avoid negative consequences, public company ESOPs that are subject to the new diversification requirements should be reviewed and, if necessary, amended to remove the pre-2007 diversification provisions and the related distribution provisions. According to the Notice, such an amendment may need to be completed prior to December 31, 2013 (although a later date may be permissible in certain circumstances).
The Notice can be found here.