IRS Releases ESOP Deductions Proposals

Among other holdings,  the IRS notice issued Wednesday specifies which corporation is entitled to 404(k) dividend deductions and also asserts that payment in redemption of employer securities held by an ESOP is not deductible.

According to REG-133578-05, one purpose of the proposed rules is to specify the belief of the IRS and US Treasury Department that the corporation actually paying the dividends on stock held in the ESOP is entitled to the 404(k) deduction. This is true, the IRS document states, “regardless of whether the employees of multiple corporations benefit under the ESOP and regardless of whether another member of the controlled group maintains the ESOP.”

On the issue of whether payments in redemption of stock held in an ESOP are deductible, the IRS document said that its legal interpretation held that such deductions were not valid.

The IRS document also includes:

• provisions under Section 404(k) that confirm that payments made to reacquire stock held by an ESOP are not deductible under Section 404(k) because such payments do not constitute applicable dividends under Section 404(k)(2) and a deduction for such payments would constitute, in substance, an avoidance or evasion of taxation within the meaning of section 404(k)(5)
• provisions under Section 162(k) that provide that Section 162(k), subject to certain exceptions, disallows any deduction for amounts paid or incurred by a corporation in connection with the reacquisition of its stock or the stock of any related person (as defined in Section 465(b)(3)(C)).