Revenue Ruling 2003-6 discusses prohibited allocations of securities in an S Corporation. IRC section 409(p) requires that an employee stock ownership plan (ESOP) holding employer securities consisting of stock in an S corporation provide that no portion of the assets of the plan attributable to such employer securities may, during a nonallocation year, accrue for the benefit of any disqualified person. IRC section 409(p) is intended to limit the establishment of ESOPs by S corporations to those that provide broad-based employee coverage and that benefit rank-and-file employees, as well as highly compensated employees and historical owners.
In general, these provisions apply to S corporation ESOPs established after March 14, 2001. S corporation ESOPs established prior to March 14, 2001 must have complied with the law by December 31, 2004. Promoters marketed arrangements involving ESOPs that hold employer securities in an S corporation for the purpose of claiming eligibility for the delayed effective date of IRC section 409(p).
This ruling describes an S corporation ESOP not eligible for the delayed effective date under IRC section 409(p) and thus is subject to the nonallocation rules of IRC section 409(p). Any taxpayer who is a disqualified person with respect to the S corporation ESOP is treated as receiving a deemed distribution of stock allocated to the taxpayer’s account and income with respect to that account. In addition, excise taxes under IRC section 4979A apply to any nonallocation year.
S Corporation ESOP Guidance
Guidance and other useful information to assist in understanding issues that may exist with S Corporation ESOPs.