Dividend deduction admin considerations

[Guest PAL100759]

What are the administrative challenges if a 401(k) plan is modified to have the company stock fund designated as an ESOP in order to deduct the dividends. All contributions are participant directed.

1. Does ADP/ACP testing have to be done separately for the ESOP and non-ESOP based on where the contributions were initially deposited?

2. Are there distribution restrictions on the ESOP money? If so, can a participant just transfer their money out of the ESOP/stock fund and move it into the 401(k) investments in order to have access?

3. Does the dividend have to be counted towards the 402(g) limit if the participant elects to have the money deposited into the plan?

Are there other complications?

Thanks

[RLL]

1. Yes.

2. The only real additional "restriction" on ESOP distributions is the right of the participant to receive distribution in company stock (and the right to a "put option" if the stock is not readily tradable). Yes...a participant could elect to transfer funds out of the ESOP if the plan document so provides. It should be easy to comply with the ESOP "diversification" requirement.

3. Reinvested dividends are not contributions.

The dividend deduction would be available only if the reinvestment is at the election of the participant. This requires disclosure in connection with the election process.

[Guest PAL100759]

Can the ESOP portion have the same inservice/hardship distrubition provisions as our existing 401(k) plan?

(our plan already provides for distributions in stock)

Can the dividend deferral election be an annual election even if the dividends are paid quarterly? What if no election is received? Can the default be to defer? If the dividends are paid instead of deferred, are they reported as income on a 1099 or a W-2?

And finally, is this one plan or two, do you need one Form 5500/annual audit or two?

Thanks.

[RLL]

Yes....the ESOP portion can have the same (or more liberal) in-service/hardship distributions provisions as the existing 401(k) plan.

There appears to be little guidance in the legislative history regarding the frequency of the participant election relating to the dividend reinvestment provision. It likely will be left to the IRS to provide guidance through regulations, which may very well ultimately require quarterly elections. Presumably, the ESOP may provide for the desired default treatment....so long as it is clearly communicated in writing to participants (and beneficiaries) as part of the election process.

If dividends are passed through to participants, the existing reporting rules under IRC section 404(k) will apply. Form W-2 would not be used...it would be Form 1099-R or 1099-DIV.

The "KSOP" which would result from the addition of an ESOP portion to the 401(k) plan would likely be a combination of two plans....a profit sharing plan (the non-ESOP portion) and a stock bonus plan (the ESOP portion)...under IRC section 401(a). However, the instructions to Form 5500 permit such a combination plan to be the subject of one annual report/return and one audit.