For-profit and tax-exempt employers should consider adopting these new rules if they offer qualified retirement plans currently or plan to offer them in the future. By the end of the plan year beginning in 2025, employers operating by the mandatory or optional changes in the law as of the provisions' effective date are entitled to adopt the written amendment unless the Internal Revenue Service (IRS) announces otherwise. A change to the plan document must be made by the end of the government's plan year in 2027.
This summary of SECURE 2.0 provisions is organised by year, regardless of plan type, to help prioritise the evaluation of the changes. This article will discuss various aspects of SECURE 2.0, including strategic opportunities and implementation challenges for employers.
SECURE 2.0 Act: Esop Rules and Regulations
The SECURE 2.0 Act modifies the term to permit highly regulated firms to regard their shares as "public" for Employee Stock Ownership Plan purposes if they have liquid securities traded on non-exchange venues. Although there aren't many ESOPs that fit this description, the move helps community banks that trade shares over the counter because it makes it simpler for them to provide ESOPs to staff members.
The SECURE 2.0 Act of 2022 fundamentally alters the administrative and legal compliance environment of retirement plans. Several papers that "deep dive" into important SECURE 2.0 rules that will impact how companies set up and manage their 401(k) plans, pension plans, and other employer-sponsored retirement plans are being written by law firms. This modification will take effect for plan years that start after December 31, 2027.
10% Tax Deferral to S Corporation ESOP Sellers
A tax deferral option that was formerly exclusively available to C corporation owners is now extended to S corporation owners via Section 114 of the SECURE Act 2.0, which alters Section 1042 of the Code. Before SECURE Act 2.0, if certain conditions are met, such as
(1) the ESOP owns 30% or more of the stock after the sale and
(2) the seller reinvesting the proceeds in stocks and bonds of US operating companies (referred to as “qualified replacement property”), Section 1042 of the Code allowed an owner of stock in a non-publicly traded C corporation to defer capital gains tax on up to 100% of proceeds from a sale to an ESOP.
S company owners may now use Section 1042 of the Code to delay gains on sales to ESOPs that close after December 31, 2027, but they can only use up to 10% of the profits for this purpose.
The Initiative for Employee Ownership
The Worker Ownership, Readiness, and Knowledge Act (WORK Act), which mandates the DOL create an Employee Ownership Initiative to encourage employee ownership at the state level, is contained in Section 346 of SECURE Act 2.0. According to the WORK Act, financing for this programme will start at $4 million in fiscal year 2025 and progressively rise to $16 million by fiscal year 2029.
The WORK Act shows that Congress supports employee ownership and instructs the DOL to carry out the Employee Ownership Initiative by awarding grants to states, serving as a clearinghouse for strategies used by both new and current state-level programmes, and sponsoring projects for outside organisations to gather data on these strategies.
The money will go towards:
Educating and reaching out to companies and workers about the advantages and opportunities of employee ownership and company ownership succession planning;
Provide technical support to workers who want to create their firms, enabling employers and workers to investigate and evaluate the viability of giving workers full or partial ownership and motivating workers and employers to launch new worker-owned enterprises;
Educating both workers and employers on how to involve workers in committees, work teams, open-book management, and other strategies that aim to get more feedback from workers and
Preparing other organisations to submit grant applications to launch new initiatives and carry out programme operations.
Modification to Employer Securities That Are Traded Publicly (2028)
Under Internal Revenue Code Section 401(a), ESOPs that own "publicly traded employer securities" and have a salary deferral or matching contribution component are required to comply with extra diversification criteria (35). "Employer securities that are readily tradable on an established securities market" are referred to as "publicly traded employer securities."
As mandated by Code Section 401(a)(35), these ESOPs must permit participants with a minimum of three years of service to diversify the employer securities allotted to their matching contribution accounts and ESOPs. Additionally, they must permit instant diversification for ESOPs that receive rollover, after-tax, or salary deferral contributions.
The meaning of "publicly traded employer securities" was broadened by SECURE 2.0. The definition will expand to include some non-exchange traded securities starting in 2028, provided that the security is not a penny stock, is not issued by a shell company, is subject to priced quotations by at least four dealers on an interdealer quotation system regulated by the Securities and Exchange Commission, and has a public float of at least 10% of outstanding shares.
Key changes: Esop Regulations Under the SECURE 2.0 Act
The first modification broadens the scope of Code Section 1042. Before the modification, Code Section 1042 allowed the owner of a C corporation that was not publicly listed to postpone up to 100% of the capital gain when the owner's stock was sold.
(i) Following the transaction, an ESOP will hold at least 30% of the C corporation's stock; and
(ii) The owner uses the sale money to purchase bonds and stocks from US-based operating corporations or "qualified replacement property."
For sales that take place on or after January 1, 2028, SECURE 2.0 extends this 1042 treatment to S corporation owners; however, it is only available for up to 10% of the sale profits.
- The second modification pertains to the diversification standards for qualified plans that possess employer equities that are publicly listed. Only ESOPs that hold matching contributions or salary deferrals (or both) are subject to Code Section 401(a)(35) rules, which also mandate that these plans provide at least three investment options (aside from employer securities) to which participants may allocate the proceeds from the sale of employer securities.
This requirement would typically be met by plans that provide a wide variety of investment options by Section 404(c) of the Employee Retirement Income Security Act of 1974, as amended (ERISA).
- SECURE 2.0's third modification instructs the DOL to launch an Employee Ownership Initiative to encourage employee ownership at the state level. $4 million will be allocated to this programme in 2025, and that amount will progressively rise to $16 million in 2029.
The initiative, which is a component of SECURE 2.0's Worker Ownership, Readiness, and Knowledge (WORK) Act, will fund projects for information gathering on those techniques by organisations outside the DOL, as well as state-level grants and the DOL serving as a clearinghouse on techniques used by new and existing programmes as well as state-level programmes.
The money can be used to train employees and employers on workplace participation programmes, educate business owners about the use of employee ownership for business transition, and offer technical assistance to evaluate the viability of transactions.
Additional uses for funds include financing feasibility studies, supplying outreach and training materials, building networks of employee-owned businesses, and establishing a data bank with resources for legal, financial, and technical advice related to business ownership.
The DOL must create "acceptable standards and procedures to establish good faith fair market value for shares of a business to be acquired by an employee stock ownership plan," according to the final modification, which is also a part of the WORK Act. Under 408(e) of ERISA, this modification aims to address long-awaited clarity on a grey area in the ESOP regulations.
When an ESOP buys stock from its sponsoring corporation, it is not considered a prohibited transaction under Section 408(e) as long as the ESOP only pays fair compensation for the stock.
According to the plan's provisions and the Secretary of Labor's rules, "adequate consideration" is defined as "fair market value of the asset as determined in good faith by the trustee or named fiduciary." Since ESOP values are the most disputed ESOP problem, the DOL has designated them as an enforcement priority since 2005. As such, the much-needed clarification provided by this widely awaited guideline would be greatly appreciated.
What comes next?
While many of the SECURE 2.0 retirement plan elements—such as the new government "Saver's Match" and required paper benefit statements—will not go into effect until later years, a few key provisions need to be addressed immediately. Small employers will particularly benefit from some of the reforms.
To accommodate SECURE 2.0, nearly all employer retirement plans will need to be examined for potential revisions and operational adjustments.
Employers should evaluate their plan document and operations in the meantime to ascertain what revisions will be required, what operations need to be adjusted, and what systems or processes should be updated, even though more information on many of the new rules is required.
Companies should speak with Especia about how SECURE 2.0 offers new possibilities and what needs to be done to lessen the effects of unfavourable developments.
What is India's highest allowable ESOP limit?
The maximum quantity of shares that can be granted under ESOPs is 10 percent of the total paid-up capitalisation of the business.
How does section 2.0 impact S businesses?
Incentives are added by SECURE 2.0 for businesses that choose to use an ESOP. It creates a Department of Labour employee ownership programme and gives S firms access to some tax incentives that were previously restricted to C businesses.
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