EGTRRA - ESOP Provision

[Guest EMozley]

In interpreting the language to determine whether an S-Corp ESOP has disqualified persons under the 10/20 test - What does it mean to look as if synthetic equity were allocated ESOP stock? What is synthetic equity? How are others applying this rule?

[IRC401]

Synthetic equity is defined in the statute.

I am guessing that Congress' primary objective was to eliminate a tax shelter involving restricted stock. S corp income isn't allocated to holders of restricted stock. If 90% of the company stock were restricted (contingent on the performance of future services) and 10% were owned by the ESOP, 100% of the S corp income would be allocated to the ESOP so that no one would owe any federal income tax on the S corp income. In addition, there would be no need to make any cash distribution to pay federal taxes, and if a distribution were made, the ESOP would receive only 10% of the cash.

If you could figure out how to get all of the non-ESOP shares restricted, you had a tremendous tax shelter.

Because of the effective date in the new law, it appears that Congress decided to give the people who got into the shelter early time to get out of it.