S Corp Non-voting stock subject to diversification?

[Guest ladycpa]

An S Corp ESOP acquired non-voting shares in addition to the voting common stock in 2004. Would those shares be subject to the diversification requirements since they were acquired post-86, even though they are not "employer securities" under 409(l)? I did not find anything that would exempt them from diversification.

[Guest rubindj]

I think you may have a bigger problem.

Unless its been changed recently, the IRS only allows one class of stock in S corps. Breaking this rule would turn the corporation into a C corp I think -- but am not sure.

[Alf]

NV stock can be designed within the one class of stock rule for S Corporations, but that is still an important issue to address because losing S status for an ESOP changes alot.

Diversification only applies to the QES in this context. The NV stock will be treated as just another non-QES asset.

[BeckyMiller]

The big deal about non-voting stock in an ESOP of an S corporation is that it is no longer a qualifying employer security. That means that the income attributable to those shares is taxable in the ESOP AND any gain on disposition of those shares would also be taxable.

The issue of losing S status would apply if the nonvoting stock has other differences from the voting common, besides just the different voting rights.

Further, there are prohibited transaction implications if the plan is leveraged and the nonvoting stock was received as a stock dividend, so some of it ended up as collateral on the loan.

[Guest ladycpa]

Thanks to all for your guidance. It is appreciated!