Employee stock ownership plans (“ESOP”) are unique creatures in the world of retirement plans and business succession planning. The rules governing ESOP are complex and often not well understood, but if done properly, ESOPs can have several benefits, which include tax savings for both employees and business owners, additional cash-flow for a business, and have the potential to pass-on the financial strength of local businesses to its employees, often resulting in increased local or regional wealth. With all the benefits that ESOP can provide a business, its current owners, and employees, it might be easy to forget some of the important requirements associated with ESOPs that must be followed. Failing to do so can result in lots of tax liability and penalties, as a Rockwell, Iowa corporation in a recent Tax Court case unfortunately found out.

On January 27, 2014, the United States Tax Court issued and opinion in the case, Ries Enterprises, Inc v. Commissioner, T.C. Memo. 2014-14. In that case the petitioner was an S corporation that created ESOP for the benefit of its sole employee, who along with his wife owned all of the shares of the corporation not otherwise owned by the ESOP. Such an arrangement as Judge Kroupa explains is exactly the type of situation that section 409(p) was created to prevent. Section 409(p) “generally limits the tax benefits available through an ESOP that owns stock of an S corporation unless the ESOP provides meaningful benefits to rank-and-file employees” as opposed to the owners or key employees of the company. Mr. Reis’s direct and deemed ownership interest in the corporation caused him to be a “disqualified person” that controlled the corporation. As a result, when the ESOP allocated benefits to Mr. Reis, the plan violated section 409(p). Significant tax consequences followed as a result—(1) an excise tax equal to 50% of the total prohibited allocation, and (2) the ESOP ceases to qualify as an ESOP.

Shuttleworth & Ingersoll, P.L.C. has a sophisticated ESOP practice with a team of lawyers who have extensive experience and understanding in all aspects of ESOP transactions. ESOPs are versatile arrangements and our attorneys are equipped to help our clients complete these transactions so that our clients’ goals are accomplished and the numerous tax and other legal requirements are satisfied. We have helped companies and business owners to establish a wide range of ESOPs for a variety of purposes. In addition we assist existing plans and ESOP trustees with the ongoing responsibilities and requirements associated with ESOP arrangements.

View more information on the basics of ESOPs and benefits they can provide.

Jonathan C. Landon
Jonathan Landon is an Attorney and Vice President with Shuttleworth & Ingersoll, P.L.C. Jon advises individuals, businesses, and tax-exempt organizations in: Federal and state tax matters; general business transactions; deferred compensation and employee benefits; and estate and succession planning.