IRS Gives Amendment Relief to Certain ESOPs

The Internal Revenue Service (IRS) is granting relief for employee stock ownership plans (ESOPs) that have to make amendments to satisfy diversification requirements.

Notice 2013-17 provides relief from the anti-cutback requirements of § 411(d)(6) of the Internal Revenue Code for plan amendments that eliminate a distribution option described in § 401(a)(28)(B)(ii)(I) from an ESOP that becomes subject to the diversification requirements of § 401(a)(35), which apply to certain defined contribution plans that hold (or are treated as holding) publicly traded employer securities.  

The notice addresses circumstances in which an ESOP that satisfied the diversification requirements of § 401(a)(28)(B)(i), by allowing distribution of a portion of a participant’s account, has become subject to the diversification requirements of § 401(a)(35). As a result of becoming subject to § 401(a)(35)(E), § 401(a)(28)(B) no longer applies and such an ESOP is no longer able to make distributions that (in the absence of the applicability of § 401(a)(28)(B)(i)) would be impermissible under other rules restricting the distribution of plan benefits before termination of employment or the occurrence of certain other events. Thus, under current rules for such plans, some in-service distribution options used to satisfy the diversification requirements under § 401(a)(28)(B) are no longer permissible.   

The relief provided by the notice allows amendment of the ESOP to eliminate all in-service distribution options previously used to satisfy the diversification requirements of § 401(a)(28)(B)(i).   

The IRS explained that in general, under § 401(a)(28)(B)(i), an ESOP must provide certain participants the opportunity to elect to direct the plan as to the investment of at least 25% of the participant’s account. The ESOP is allowed to satisfy the diversification requirements by, among other means, distributing the portion of a participant’s account that is covered by the election within 90 days after the period during which the election may be made. However, Section 401(a)(35), which was added by Section 901(a)(1) of the Pension Protection Act of 2006 (PPA), requires an applicable defined contribution plan within the meaning of § 401(a)(35)(E) to meet certain diversification requirements with respect to investments in employer securities, and the diversification requirements cannot be satisfied by distributing a portion of the participant’s account.  

Notice 2013-17 is here.