ESOPs with Discontinued Contributions
You may have an ESOP or work with a company where the employer has suspended contributions to the plan. While an employer is not required to contribute to a plan each year, contributions must be recurring and substantial. To the extent the ESOP has “complete discontinuance” of contributions, the plan is treated as terminated for vesting purposes and affected employees must become 100% vested, as stated in IRC Section 411(d)(3).
Complete Discontinuance vs. Suspension of Contributions
One area to be cautious is when a plan has suspended contributions for a period of years. The IRS may view the suspension as a complete discontinuance, requiring the 100% vesting requirement mentioned above. Treas. Reg. §1.411(d)(1) provides guidance in determining whether a suspension constitutes a discontinuance:
For purposes of this section, a complete discontinuance of contributions under the plan is contrasted with a suspension of contributions under the plan which is merely a temporary cessation of contributions by the employer. A complete discontinuance of contributions may occur although some amounts are contributed by the employer under the plan if such amounts are not substantial enough to reflect the intent on the part of the employer to continue to maintain the plan. The determination of whether a complete discontinuance of contributions under the plan has occurred will be made with regard to all the facts and circumstances in the particular case, and without regard to the amount of any contributions made under the plan by employees. Among the factors to be considered in determining whether a suspension constitutes a discontinuance are:
(i) Whether the employer may merely be calling an actual discontinuance of contributions a suspension of such contributions in order to avoid the requirement of full vesting as in the case of a discontinuance, or for any other reason;
(ii) Whether contributions are recurring and substantial; and
(iii) Whether there is any reasonable probability that the lack of contributions will continue indefinitely.
IRS Audit Guidelines
The IRS stated in Announcement 94-101 that an issue of discontinuance arises when the employer has failed to make substantial contributions for at least 3 years in a 5-year period. At that point, the IRS requires the employer to prove a complete discontinuance has not occurred.