S corporation ESOP guidance


The office of Employee Plans of the Tax Exempt and Government Entities Division of the IRS sent out letters to the adopters of certain Employee Stock Ownership Plans (ESOPs) to make them aware that:

  1. Their ESOP may be affected by a change made to the Internal Revenue Code applicable to S corporation ESOPS that is generally effective on January 1, 2005, and
  2. The IRS has identified a number of S corporation ESOPs that have entered into abusive transactions.

The following information will assist you in understanding these two issues.

  • S corporation ESOP abuses PDF
    • Change in law
    • Abusive transactions involving ESOPs
    • ESOP requirements
    • Tax consequences of abusive ESOPs
    • What you should do if you are involved with an abusive ESOP
    • Qualified amended returns
  • IRS ESOP information letter PDF sent to S corporation ESOP sponsors

IRC Section 409(p) guidance

Internal Revenue Code Section 409(p)

Prohibited Allocations of Securities in an S Corporation.

Use of Transfers to Prevent a Section 409(p) Nonallocation Year PDF

Plans can use this IRS approved transfer verbiage to avoid a Section 409(p) nonallocation year.

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. (12/16/2006) See Treasury, IRS Issue Section 409(p) Final Regulations press release for more information.

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.

Revenue Ruling 2003-6 PDF

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).

Other guidance

Temporary and proposed regulations

ESOP and Subchapter S Corporations (issued December 16, 2004)

These regulations are generally applicable for plan years beginning on or after January 1, 2005. However, there are a number of special effective dates and transition rules. News release IR-2004-150 (December 16, 2004) announced the issuance of these proposed and temporary regulations.

Proposed and temporary regulations

ESOP and Subchapter S Corporations (issued July 21, 2003)

These regulations are generally applicable with respect to plan years ending after October 20, 2003.

Abusive transactions involving retirement plans

Listed transactions, guidance and other resources regarding abusive transactions involving retirement plans.

Additional resources

Employee stock ownership plans

ESOP determination letter application review process

Amend or update a plan

Forms and pubs