Abusive S-corp ESOP?

[Brenda Wren]

Just looking for opinions and thoughts here....Would you say that an S-corp ESOP that doesn't allow distributions to terminees until after the stock acquisition loan is fully repaid abusive? Probably not, but would your answer change if the note was a 30-year note? Would it cause further concern if the plan provided for 5-year cliff vesting with no credit for service prior to the plan? Is a 5% fixed loan rate reasonable? Would you be involved with a case like this in any way?

[stephen]

No distributions until 30 year note is paid off concerns me.

However, 5 year cliff with no credit for prior service is ok along with a 5% fixed interest rate. I have heard of ESOPs using LIBOR rate as the rate for the internal loan (currently 20 year LIBOR is under 5%).

I would also be concerned if the S-corp ESOP is being set up in a way to avoid taxation without providing broad based ownership.

[RLL]

Hi Brenda Wren ---

Such an ESOP would be in violation of the distribution requirements of IRC section 409(o)(1)(A).

Note that the exception for financed shares in section 409(o)(1)(B) applies only to loans described in section 404(a)(9), which does not apply to S corporations per section 404(a)(9)©.