Prohibited Allocations When Shareholder Waits to Elect 1042

[Guest kredlin]

How does an ESOP track selling shareholders who elect 1042 treatment in order to avoid engaging on prohibited allocations? For example, the selling shareholders have until their 1040's are due to elect 1042 treatment. What happens if the ESOP makes an allocation before this deadline and gives an allocation to a selling shareholder that hadn't elected 1042 treatment at that time, but subsequently does? The shareholder had not made a 1042 election at the time of the allocation, but later did. Does that allocation become a prohibited one?

[RLL]

Hi kredlin ---

The allocation of shares (acquired in a 1042 transaction) to a selling shareholder who elects 1042 tax-deferred treatment is a prohibited allocation under IRC section 409(n), as the election under section 1042 becomes effective retroactively to the sale date.

It's very easy for an ESOP company to "track" selling shareholders who may elect under section 1042. Under section 1042(B)(3), the company must consent to the 1042 election. The "safe" way to administer the ESOP is to treat any selling shareholder who is given a written consent by the company as being subject to the section 409(n) allocation prohibitions; and the terms of the 1042 transaction should specify that a shareholder may only request the consent prior to the time the allocations are to be calculated.