April 2, 2009

Employee Stock Ownership Plan (ESOP)

Your Guide

A defined contribution plan for which the primary investments are employer stocks ( stocks of the employer that sponsors the plan)
In order to be treated as an ESOP under the tax code, the plan must meet certain requirements, including the following:
The plan must be formally designated as an ESOP in the plan document
The plan must specifically state that it is designed to invest primarily in qualifying employer securities. As such, a money purchase pension plan or a stock bonus plan constituting an ESOP may invest part of its assets in other assets ( other than qualifying employer securities).
Referring Cite
ERISA §407(d)(6)(A) , IRC §401(a)
Additional Helpful Information

An ESOP can be part of a defined contribution plan (other than an ESOP)
If an existing defined contribution plan is converted to an ESOP, the fiduciary and exclusive-benefit rules apply to the conversion.
According to 28 CFR 2550.407d-6, a plan constitutes an ESOP for a plan year, only if it meets other such requirements as the Secretary of the Treasury may prescribe by regulation under IRC§ 4975(e)(7)


Written By

Retirement Dictionary Staff

Frequently Asked Questions Regarding

Answer: The 6% excise tax applies when an excess contribution is made to an IRA, and it is not properly corrected by the IRA owner’s tax filing due date, plus extensions.

For example: If you make an excess contribution to your IRA for 2020 and you do not correct it by you 2020 tax filing due date, including extensions, you will owe the IRS a 6% excise tax for 2020, and for every subsequent year the amount remains in your IRA as an excess contribution.

Therefore, your tax preparation software should not be showing an 6% excise tax for your excess contribution if your indicate that the excess has been or will be properly corrected by your tax filing due date, plus extensions.

Why You Have an Excess Contribution

You must have eligible compensation to be eligible to make a regular contribution to an IRA. Eligible compensation includes wages and self-employment income. Because your only income is social security, you are not eligible to make a regular contribution to an IRA (For purposes of making a contribution to an IRA, social security income is not considered eligible compensation).

Therefore, your entire IRA contribution is an excess contribution.

Since you are still within the deadline for correcting your 2020 IRA excess contribution, you will not owe the 6% excise tax as long as you distribute the excess, along with any net income attributable, by your tax filing due date, including extensions. If you miss this deadline, you will owe the IRS a penalty for 6% of the excess contributions, for every year the excess remains in your IRA.

How to Correct the Excess Contribution

The question now becomes, since you do have an excess contribution, what should be done to have it corrected so as to avoid the 6% excise tax?

The solution: You should remove the amount from your IRA as a ‘return of excess contribution.’ You have until your tax filing deadline, including extensions, to remove the amount as a return of excess contribution. Since you already filed your tax return (which means you filed it by the deadline), you receive an automatic 6-month extension to correct the error (under the return of excess method). This automatic 6-month extension means that you have until October 15 to correct the error.

The 6% excise tax applies only if you fail to remove the excess amount by the deadline.

• Contact your IRA custodian and instruct them to remove the IRA contribution as a return-of-excess contribution. They may have a special form for this purpose.

 • Ensure that any net income attributable (NIA) to the excess is removed along with the contribution. NIA can be earnings or losses.

 • Amend your tax return to remove the 6% penalty.

Your IRA custodian will send you a Form 1099-R for the correction by January 31 of next year. If there are any earnings removed with the excess, you will need to include them on your tax return filed for this year.

Please be sure to consult with your tax advisor.  

Yes. You can recharacterize a percentage of your IRA contribution. Bear in mind that amounts being recharacterized must include any net income attributable (NIA) to the amount. Computation of the NIA requires use of the formula provided here https://www.retirementdictionary.com/definitions/netincomeattributablenia.
As a reminder, the deadline for completing your recharacterization is your tax filing due date. If you filed your tax return by the due date, or filed for an extension by the due date, you receive an automatic 6-month extension to complete the recharacterization. For calendar year tax filers, this extended deadline would be October 15[1].

[1] The deadline is extended to the next business day, if October 15 falls on a non-business day.


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