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EP Abusive Tax Transactions - S Corporation ESOP Abuses: Certain Business Structures Held to Violate Code Section 409(p)

Revenue Ruling 2004-4
The Treasury Department and the IRS issued Revenue Ruling 2004-4 to identify certain business structures which will be treated by the IRS as avoiding or evading section 409(p) of the Internal Revenue Code. The ruling designates transactions in which profits are set aside in a Q-Sub or similar entity such as an LLC, as "listed transactions" for purposes of the tax shelter regulations, including the disclosure requirements.

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. 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. This is an important tax break which allows the company to reinvest profits on a tax-deferred basis, for the ultimate benefit of employees who are ESOP participants.

The ruling shuts 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.  For example, 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.

Press Release
The Treasury Department and the IRS issued a ruling to shut down abusive transactions involving "S corporation ESOPs." (01/23/2004)

S Corporation ESOP Guidance
Guidance and other useful information to assist in understanding issues that may exist with S Corporation ESOPs.

Treasury, IRS Issue Section 409(p) Final Regulations
The Treasury Department and IRS issued final regulations under Section 409(p). That section of the tax law generally prohibits accruals or allocations under an employee stock ownership plan (ESOP) that holds stock of an S corporation where the ownership interest in the ESOP or in rights to acquire the corporation are so concentrated among 10 percent owners that they hold 50 percent or more of the interests in the corporation. The final regulations are available for review. (12/16/2006)

Page Last Reviewed or Updated: 17-Sep-2013