New Bill - S Corp ESOPs

[Dawn Hafner]

Does anyone have any S Corp ESOPs that will not meet the broad ownership test in the new bill? If so, what are your plans with any action to take on the plan. If the S corp is considered owned 50% by disqualified perons, then not only are future allocations in the ESOP to disqualified persons taxed at a rate of 50%, but in the first year effective (1/1/2005 for existing calendar year S corp ESOPs) the "allocated stock" (i.e. exisitng account balances?) of disqualified persons are also taxed at a rate of 50%, even if no new allocations are made.

Will these S corp ESOPs be forced to terminate prior to 1/1/2005. Will that solve the problem, or will the IRS apply the same type of logic to an S corp ESOP that terminates? Per NCEO article "The conference report directed the IRS to develop regulations to define exisiting plans as subject to this legislation, regardles of when they were established, if their purpose is "in substance, and avoidance or evasion of the prohibited allocation rule".

This situation is a company that had their ESOP for many years as a C corp, and when the S corps were allowed to sponsor ESOPs they converted. They have a few large shareholders, and this will be a problem for them. Any problems with terminating the plan? I realize this is a fiduciary decision, that must be made in teh interest of the participants, but if the employer has to pay a tax bill of $xxx, the long term prospects for the company itself may be effected. I also realize that this is the type of situation that this legislation is designed to prevent, but what to do about those already in place. They were simply taking advantage of the fact that converting to S corp made sense for them at the time. Any insight?

[stephen]

Could the company elect to revert to C-Corp status effective 1/1/2005?

[IRC401]

Other possible solutions:

- sell the stock to other employees' accounts

- take a distribution

- transfer to a profit-sharing plan (and pay UBIT)

- have the company buy back the stock

[Guest EMozley]

Dawn, I would like to revive your thread regarding how you will treat an S-Corp ESOP under the new rules. We are currently looking into a similar situation (elected an ESOP in 1999 because it made sense) that looks like the plan will fail the 10/20 rule. I was wondering if you or anyone else had made any headway on the fix?

[stephen]

I am interested in learning more of the details and intricacies involved with the New S-Corp ESOP restrictions and how they work.

How does this rule apply for non-calendar year plans?

How is the ownership determined for the unallocated shares in the ESOP?

What planning options are available between now and December 31, 2004? (We would like to help our clients avoid having a non-allocation year and maintain their S-Corp status where possible.)

Is it possible to set up a stock option plan or complete additional ESOP transactions to dilute the ownership?

Could you:

- sell the stock to other employees' accounts

- take a distribution

- transfer to a profit-sharing plan (and pay UBIT)

- have the company buy back the stock

Are there some situations where your only option will be to revert to C-Corp effective 1/1/05? Or terminate the ESOP effective 12/31/04?

[Guest boberlander]

Unallocated shares in the ESOP would be deemed to be owned by each participant based upon his proportion of allocated shares as of the most recent stock allocation (Sec. 656 under Deemed-owned shares and Person's shares of unallocated stock).

If "disqualified person" is determined by stock held within the plan, does that meant that any new plan would have to be set up to exclude from participation the potential disqualified persons until ownership is broad-based?

Or, at least until the person could enter the plan and not accrue allocated and unallocated shares equal to 10% of all plan shares? (Assume no family members).

[waid10]

I wanted to revive Dawn's posting. Does anyone have an S Corp ESOP that will violate 409(p) effective 1/1/05? What options are you providing to shareholders?