ESOPs Using S Corporation Tax Shelters Get No EGTRRA Delay

According to Washington-based legal publisher BNA, the US Treasury Department and the Internal Revenue Service (IRS) are also trying to shut down the practice as well.

EGTRRA made the rules effective for plan years after December 31, 2004, or after March 14, 2001, for an ESOP established after that date or if the employer securities held by the plan consist of stock in an S corporation that did not have an S designation on that date, according to the BNA report.

IRS said that for the purposes of the new rules, an ESOP is not established until it is adopted by an employer for the purpose of enabling its employees to participate in a more than insubstantial manner in the ownership of the employer’s business. The ESOP also has to provide its employees with more than insubstantial benefits under the ESOP.

Because more than insubstantial benefits were not offered under the ESOPs using the S corporation tax shelters, the ESOPs are not treated as having been established on or before March 14, 2001, and are not entitled to the delayed 2005 effective date for the new rules, the two government agencies said.

Tax code Section 409(p) requires that an ESOP holding stock in an S corporation provide that no portion of the assets attributable to the employer securities accrue, during a nonallocation year, for the benefits of any disqualified person. A disqualified person is someone who, along with family members, owns more than 20% of the stock in the S corporation, or alone owns more than 10% of such stock.