S Corp ESOP Abuse Window Closed

January 26, 2004 (PLANSPONSOR.com) - On Friday the Treasury Department and the IRS issued a ruling to shut down what the agencies described as "abusive transactions involving S corporation ESOPs."

>An employee stock ownership plan, or “ESOP,” is a type of retirement plan that invests primarily in employer stock.   Congress has allowed an “S corporation” to be owned by an ESOP, but only if the ESOP gives rank-and-file employees a meaningful stake in the S corporation.  

>According to a Treasury Department news release, when an ESOP owns an S Corporation, the profits of that corporation generally are not taxed until the ESOP makes distributions to the company’s employees when they retire or leave the job – an important tax break that allows the company to reinvest profits on a tax-deferred basis, for the ultimate benefit of employees who are ESOP participants.

>However, Revenue Ruling 2004-4 makes these “listed transactions” for tax-shelter disclosure purposes, thus shutting down transactions that move business profits of the S corporation away from the ESOP, so that rank-and-file employees do not benefit from the arrangement. The news release notes that the ruling prohibits using stock options on a subsidiary to drain value out of the ESOP for the benefit of the S corporation’s former owners or key employees.

“Congress recognized the potential for attempts to circumvent the rules and specifically authorized Treasury and IRS to prevent it. This notice does just that, imposing a 50% excise tax on the option holders in cases where rank-and-file ESOP participants are deprived of the business profits,” stated Treasury Assistant Secretary for Tax Policy Pam Olson.

You can read MORE about the ruling at http://www.treas.gov/press/releases/reports/js1114attachment1.pdf