Prohibited Allocations

[Guest RBJ]

Several years ago, my client established an ESOP purchasing 35% of company's stock from one shareholder. Selling shareholder elected 1042 treatment. Seller's son works for company and has and will not receive allocations due to attributed ownership of his father's shares. Several years later, when all shares in purchase #1 have been allocated, ESOP is purchasing additional shares from a person unrelated to first selling shareholder (and also unrelated to the son).

Is the son still considered a 25% shareholder? 409(n)(3)(B)(i) seems to say yes, if you measure the one year pre-sale period by looking at both purchase #1 and purchase #2. This strikes me as an unintended result and it seems more equitable to apply the 25% shareholder definition on a transaction by transaction basis. Under that approach, the son would be a 25% shareholder for purchase #1 but not for purchase #2.

Is anyone aware of IRS interpretations of 409(n)(1)(B) supporting either approach?