EP Abusive Tax Transactions - S Corporation ESOP Abuse of Delayed Effective Date for Section 409(p)


Revenue Ruling 2003-6PDF 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.

Other resources

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