ESOPs & Employee Benefits Q2 2022 Client Update | Kaufman & Canoles


Happy Summer from the K&C ESOPs & Employee Benefits practice group. We’ve compiled a short list of employee benefits updates from the second quarter of 2022.

Last Call for Pre-Approved Plan Restatements

As Summer kicks into high gear, the window for pre-approved 401(k) plan document restatements is rapidly drawing to a close. As most plan sponsors are aware, the IRS requires the restatement, or complete replacement, of pre-approved 401(k) plan documents every six years. Plans must be restated even if the employer does not wish to make any changes to the plan terms. The current six-year cycle, often called “Cycle 3,” ends on July 31, 2022; failing to complete the plan restatement by that deadline will result in penalties. For plan sponsors who have not yet completed their restatement, time is now of the essence. We encourage any employers who have not completed the process to contact their plan document providers as soon as possible.

IRS to Allow Employers Time to Conduct “Pre-Audit” Compliance Checks

The IRS announced in early June a new pilot program aimed at reducing the burden of retirement plan audits for both plan sponsors and IRS personnel. Under the new pilot program—the exact details and duration of which remain unclear—the IRS will send retirement plan sponsors a “pre-audit” letter informing the plan sponsor that its plan has been selected for audit. The plan sponsor will then have 90 days to review its own plan document and operational compliance and correct any errors it discovers on its own. Once the plan sponsor submits its findings to the IRS, the IRS will decide whether to close the matter, conduct a limited audit, or proceed with a full audit. To incentivize plan sponsors to uncover and correct plan mistakes on their own, the pilot program will allow employers to correct errors using either a self-correction or the more favorable voluntary correction fee schedule—which tops out at $3,500—as opposed to the regular audit process that requires individual negotiation of fees that are unpredictable and often far steeper than the voluntary correction fee schedule.

In short, the IRS is allowing plan sponsors to take the first opportunity to audit themselves and voluntarily report any mistakes. While that may sound counterintuitive, the availability of reduced correction fees and the possibility of avoiding a full IRS plan audit should prompt employers to take the pre-audit compliance review seriously.

Retirement Plan Legislative Proposals—Including ESOP Provisions—Continue to Accumulate

Our first quarter update briefly mentioned the House-passed “SECURE 2.0” Act, noting that it was far from final. Since then two competing proposals have been introduced by different Senate committees—the “RISE & SHINE Act” and the “EARN Act”—both of which contain some similar provisions but also a great many differences. The bills collectively address a significant amount of ground, although in some cases in different ways, including new types of 401(k) safe harbor plans; adjustments to catch-up contributions and required minimum distributions; new or enhanced tax credits; matching contributions for student-loan payments; and a multitude of other substantive and technical changes.

Interestingly, and somewhat outside of the norm, these bills all include provisions specifically aimed at ESOPs, further reinforcing the understanding that ESOPs continue to have bipartisan Congressional support.

The Senate’s RISE & SHINE Act includes two favorable provisions for ESOPs. The first directs the Department of Labor (DOL) to issue long-overdue regulatory guidance on determining the good faith fair market value for shares of a business acquired by an ESOP. Often called “adequate consideration,” this formal guidance has been absent since the passage of ERISA in 1974. The second is a provision authorizing up to $50 million in grants over five years from the DOL to increase education and awareness about employee ownership and to promote employee ownership in states and localities. This would be the first federal grant program specifically dedicated to promoting employee ownership and ESOPs.

The EARN Act also includes a provision limiting limiting section 1042 tax deferral to S corporation ESOPs. Section 1042 of the tax code allows certain selling shareholders to defer capital gains taxes on eligible stock of a C corporation sold to an ESOP if the proceeds of the sale are reinvested in certain types of replacement investments. This tax treatment is an important incentive for ESOP formation but is currently not available with respect to S corporations. This EARN Act provision matches a similar provision in the House’s previously passed “SECURE 2.0” Act. The proposal would allow up to 10% of capital gains to be deferred in the sale of S corporation stock to an ESOP, but would not take effect until January 1, 2028.

As is clear, there are still a number of issues that must be reconciled before these bills advance, but there appears to be continued momentum and bipartisan support in Congress for significant retirement legislation in the near future.

Health Plan Transparency Rules Take Effect

Moving away from retirement plans, employers who sponsor group health plans must be prepared for a portion of the transparency in coverage rules that take effect July 1, 2022. Under the new regulations, group health plans must begin to make available separate “machine-readable “files containing data on certain claims payment amounts under their group health plans. These files must be posted in a specific file format on a publicly available website that anyone can access. Thankfully, for employers whose group health plans are fully insured by a group health carrier, the carrier will be primarily responsible for compiling and posting the public data. Employers who sponsor self-insured group health plans may contract with a third-party (generally the plan’s TPA or claims administrator) but are not relieved of the ultimate obligations to post and maintain the files. Employers who have not yet coordinated with their group health carrier or TPA on these requirements should contact their broker to ensure compliance.

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