New ESOP Rules

May 11, 2011

Economic Growth and Tax Relief Reconciliation Act of 2001

Comparison of Old and New Provisions

Current Law

New Law (EGTRRA)

I. Increases in Contribution, Deduction and Benefit Limits

Contribution Deduction Limits: An employer’s deduction for contributions (including 401(k) deferral contributions) to a profit sharing or stock bonus plan is limited to 15% of participants’ taxable compensation. The money purchase plan limit is 25%.

The 15% deduction limit is increased to 25%.
401(k) deferrals do not count against the limit.
Compensation used to determine deductions includes deferrals.
Money purchase plan limit remains at 25%.

Effective:
Employer’s taxable
years beginning after December 31, 2001

Individual Benefit and Contribution Limits: Allocations of employer and employee contributions and forfeitures in a profit sharing, 401(k) or other defined contribution plan cannot be greater than the lesser of (i) 25% of gross pay or (ii) $35,000 (indexed).

Allocations of employer and employee contributions and forfeitures cannot be greater than the lesser of (i) 100% of gross pay or (ii) $40,000 (indexed).

Effective:
Limitation years beginning after December 31, 2001

Annual Compensation: Currently a qualified retirement plan can consider up to $170,000 of pay to determine benefits and contributions.

The limit is increased to $200,000, and will be indexed in $5,000 increments thereafter.

Effective:
Plan years beginning after December 31, 2001

II. ESOP S Corporation Changes and Dividends

Anti-Abuse Rules for S Corporation ESOPs: No provision.

If ownership of S corporation shares in an ESOP is or becomes highly concentrated among one or more “disqualified persons” (and certain family members), there is an excise tax of 50% of the value of the shares allocated to, or synthetic equity owned by, the disqualified person. A disqualified person who receives a prohibited allocation is also taxable on the value of the shares allocated to his or her ESOP account.

Effective:
Plan years ending on or after March 14, 2001, if the ESOP was not established before that date or the corporation did not have an S election in effect by that date.

Otherwise, plan years beginning after December 31, 2004

Deduction for ESOP Dividend Reinvestment: Employer cannot take a deduction for dividends that remain in an ESOP for reinvestment.

An employer can deduct dividends
paid to an ESOP if the participants may elect to
receive the dividends in cash or to have them reinvested
in employer stock within the ESOP.

Effective:
Tax years beginning after December 31, 2001

III. 401(k) Plans

Elective Deferrals: $10,500 is the maximum limit on pre-tax contributions to 401(k) plans.

The limit is increased to $15,000
as follows:

Year	Limit
2002	$11,000
2003	$12,000
2004	$13,000
2005	$14,000
2006	$15,000

Effective: Tax years beginning after December 31, 2001

Catch-up Contributions: No provision.

Participants age 50 or older may make annual catch-up contributions to 401(k) plans and certain other salary reduction arrangements.

Year	Limit
2002	$1,000
2003	$2,000
2004	$3,000
2005	$4,000
2006	$5,000

Make-up contributions are limited to a participant’s annual compensation reduced by other deferrals if less than these limits. The limit on make-up contribution will be indexed in $500 increments.

An employer can decide to consider make-up contributions in determining a matching contribution.
For purposes of nondiscrimination and deduction purposes, make-up contributions will be treated as follows
- Do not count against the dollar limit on deferrals
  ($11,000 in 2002).
- Do not count against the allocation limit
  ($40,000 in 2002).
- Do not count against the 25% limit on tax deductions.
- Not subject to plan’s terms that limit deferrals.
- Not subject to 401(k) ADP test.
- If matching
  contributions are based on make-up
  contributions, the match has to satisfy the ACP test

Effective:
Taxable years beginning after December 31, 2001

Faster Vesting for Matching Contributions:

The minimum vesting schedules are:

5 year cliff vesting (0% vested percentage until the completion of 5 years of vesting service), or
A graded vesting schedule beginning with 20% at 3 years and 100% after 7 years.

The minimum vesting schedule for matching contributions are:

3 cliff vesting (0% vested percentage until
the completion of 3 years of vesting service),
or
A graded vesting schedule beginning with 20% at 2 years with full vesting after 6 years.

This change does not apply to other types of contributions.

Effective:
Plan years beginning after December 31, 2001.

Prohibition on “Multiple Use” Repealed: The multiple use test prohibits a 401(k) with matching contributions from relying on the alternative limit (lesser of 200% or 2 percentage points difference) for both the ADP (deferrals) and ACP (match and after-tax) tests.

The multiple use test is eliminated.

Effective:
Years beginning after December 31, 2001

“Same Desk” Rule Repealed: Following a merger or acquisition, a 401(k) plan cannot distribute benefits to a participant employed by the buyer if the participant continues at the same job at the “same desk.”

The same desk rule is repealed allowing the acquired company to distribute benefits to participants who continue to work for the buyer at the same job after the merger or acquisition.

Effective:
Distributions after December 31, 2001

Hardship Rules Liberalized: A plan must suspend a participant’s salary deferral contributions for 12 months following a hardship withdrawal in order to satisfy the safe harbor for in-service distributions.

The 12-month suspension period can be shortened to 6 months.

Effective:
Years beginning after December 31, 2001

Roth Contributions to 401(k) Plans. Withdrawals of after-tax contributions and earnings are taxed on a pro-rata basis upon distribution.

401(k) plans may permit participants to make “Roth” contributions, which are included in taxable compensation when made. These contributions and earnings will be treated as elective deferrals but will not be subject to tax in the year they are distributed.

Effective:
Tax years beginning after December 31, 2005

IV. Rollovers

Rollover Rules Expanded: Rollovers from a qualified retirement plan can be made only to another qualified plan or an IRA. After-tax contributions cannot be rolled over.

Distributions from qualified plans can be rolled over to any of these plans or an IRA.
Distributions made from an IRA to which the participant has made deductible contributions may be rolled over to an IRA or a qualified plan.
After-tax contributions may be rolled over to an IRA or qualified plan or transferred to a qualified plan in a direct trustee-to-trustee transfer.

Effective:
Distributions after December 31, 2001

Automatic Rollovers: No provision.

The plan must provide for an automatic rollover to an IRA of involuntary cash-outs between $1,000 and $5,000, unless the participant requests otherwise.

Effective:
Upon issuance of final IRS regulations

V. Small Employer Plans

Small Business Tax Credit: No provision.

A “small employer” is entitled to a tax credit equal to 50% of the first $1,000 in expenses for plan administration and retirement education.
A “small employer” is an employer whose plan covers at least one non-highly compensated employee and has 100 or fewer employees earning more than $5,000 each.

Effective:
For costs paid or incurred after December 31, 2001 for plans established after that year

Determination Letter Fees: A small employer must pay the same user fees as other employers.

A “small employer” (as defined above) is not required to pay a user fee for a determination letter request, subject to certain timing requirements for the request.

Effective:
Requests after December 31, 2001

VI. Top-Heavy Rules

Top-Heavy Rules Liberalized: For top-heavy purposes, a “Key Employee” is determined based on a five-year look back. Officers who earn more than $70,000 are Key Employees. Matching contributions are not counted toward the top-heavy contribution minimum.

These complicated rules have been
simplified as follows:

Key employee definition is
modified to include (1) an officer with compensation greater than $130,000, (2) a 5% owner, and (3) a 1% owner with compensation greater than $150,000.
Matching contributions can be counted toward satisfying the minimum 3% contribution requirements.
Four-year look back rule is shortened to one year. 401(k) plans that adopt the “safe harbor” matching contribution plan design are exempt from the top-heavy rules.

Effective:
Years beginning after December 31, 2001