IRS Distributes Final ESOP Redemption Rules

August 30, 2006 (PLANSPONSOR.com) - Federal officials have released final tax rules, which feature without significant changes proposed regulations governing deductions for payments to redeem employer securities held by an employee stock ownership plan (ESOP).

The regulations from the US Treasury Department and the Internal Revenue Service (IRS) deal with whether companies are eligible to deduct applicable dividends under tax code Sections 162(k) and 404(k). The rules allow only payer corporations, rather than employer companies, to tax deductions for dividends paid for stock held in employee stock ownership plans.

According to the final rules:

  • Payments made to reacquire stock held by an ESOP are not deductible under Section 404(k) because such payments are not applicable dividends under Section 404(k) (2).
  • Amounts paid to reacquire stock include amounts paid by a corporation to reacquire its stock from an ESOP that are then distributed by the ESOP to its participants (or their beneficiaries).

The officials said Congress did not intend to authorize yet another deduction for the full value of the shares upon their redemption.

“To allow a deduction for redemption proceeds would be to allow a second deduction that includes the present value of dividends that are paid out after the date of distribution from the ESOP, contrary to the intent of the statute,” the final regulation said. The amount of the deduction to connect to a redemption could be many times the amount that would be deducted for that year for a conventional dividend, it added.

The rules are here .

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