Taxation of Stock Distribution

[Kirk Maldonado]

Assume that an employee receives a distribution from an ESOP, where there has been no appreciation in the stock since the date on which the stock was acquired by the ESOP (so there is no Net Unrealized Appreciation). The employee then requires that the employer repurchase the stock pursuant to the put option rules. The employer elects to pay the price in installments over 5 years.

Many people only report as income the cash amounts as they are received from the employer. However, it seems to me that the employee is taxed upon the full value of the stock when he or she receives the distribution. Thus, the fact that the employee enters into an installment sale immediately after receiving the stock does not preclude taxation on the full value of all of the shares that are received.

Does anybody have any citations of authority (or well-reasoned opinions) that would justify a different result?

[RLL]

Hi Kirk ---

You're asking for the impossible.

So long as there is a total distribution of the stock, no IRA rollover, the repurchase is made by the employer from the distributee, and the repurchase payments are coming from the employer, I see no way that one could interpret IRC section 402 to support income taxation on a basis other than what you think.

How is the distribution reported on Form 1099-R? Maybe the report to the IRS reflects the distribution as though it were made on an installment basis. In that case, although it is clearly incorrect, the IRS might never know...unless it audited the ESOP and discovered the incorrect reporting. Of course, no one should advise a client to do this.

[Kirk Maldonado]

RLL:

I need to make full disclosure.

I think that the position that the employee isn't taxed at the time of the distribution is wrong. However, I am having a fight with another law firm that is asserting that position. I was looking to see if there is any support for their position prior to a conference call with them.

It also involves a prospective transaction involving a substantial number of employees.

[Guest EAKarno]

Kirk,

If there is no NUA, why would anyone want a distribution up front in a lump sum with a repurchase over 5 years? Why not receive a distribution with a simultaneous repurchase over the same 5 years? Under the facts as you describe them, I don't see any value to the participant in holding the shares personally, rather than in the trust, in the 5 year interim period.

[Kirk Maldonado]

EAKarno:

I agree with your response. However, it conflicts with the advice that the other law firm gave the participant. Specifically, they said you could sell everything today, but only be taxed when you receive the installment payments.

One reason why somebody would want to sell all of the stock today, rather than incrementally, is that they think that the stock price could go down.

[RLL]

EAKarno ---

It may be that participants don't have a choice. Perhaps the ESOP permits only lump sum distributions. The employer may have designed the ESOP in this way to assure that all stock allocated to a participant is distributed and repurchased at the earliest distribution date. This would avoid the administrative burden of maintaining the distributee's account under the ESOP (he/she would be converted from an ESOP participant to a company creditor) and would prevent the former employee from continuing as a beneficial shareholder.