Nonvoting Stock in an S Corp ESOP

[Guest texastax]

Whether an S corp ESOP (no readily tradable common stock) is permitted to hold nonvoting securities of the employer (satisfies the S corp requirement as to a single class of stock). It seems that § 409(l) does not permit it. Any insight would be greatly appreciated.

[RLL]

Hi texastax ---

It is clear that the nonvoting stock would not be "employer securities" under IRC section 409(l). However, an ESOP under IRC section 4975(e)(7) is merely required to be "designed to invest primarily in employer securities." Accordingly, so long as the ESOP meets that requirement (probably through being more than 50% invested in the employer's voting common stock), it could also hold shares of the nonvoting common stock.

Note, however, that the IRC section 512(e)(3) S corporation ESOP exception to taxation of unrelated business income would be limited to the ESOP's interest in the voting stock....that is, the S corporation taxable income attributable to the ESOP's nonvoting stock would be subject to tax.