409(p) - first year and subsequent year issues

[Belgarath]

I have a hypothetical question, but based upon a potential real-life situation where client currently has C-corp with a 401(k) plan, and is now suddenly interested in converting to an S-corp with an ESOP, for reasons unknown. I'm just trying to consider some background. Numbers are hypothetical and rounded for simplicity. For purposes of the example, assume 1,000 total shares, all to be owned by the ESOP, with no synthetic equity and no family members.

So, in first year, since there is no prior valuation to use to calculate "deemed owned" shares, you must use a "reasonable
" method." I'd assume that the actual first year allocation/share release would typically be a "reasonable" method? So, let's say 140 shares allocated/released, and of those, 60 are allocated to Mr. Big. This represents 43% of the total share release for 2014. So for his deemed ownership, you start with the 60 shares, then you take 43% of the remaining 840 shares, or 360 shares, for a total of 420 shares - app. 42% of the total.

First, have I got that right? If so, that's pushing the 50% in the first year. So, say you then amend the plan to exclude Mr. Big from receiving further allocations. You still aren't necessarily off the hook, because an "impermissible accrual" includes ACCUMLATED allocations from prior years (although I can't offhand see how he'd reach 50% if he is ineligible to ever receive an allocation, barring some new family issue or synthetic equity situation?) I'd think perhaps the client's legal/tax counsel would perhaps advise Mr. Big against participating even in year one?

I've seen very few ESOP's, and the ones I've seen are mostly small S-corps where the Head Honchos are excluded from day one cause they can't pass 409(p).

Appreciate any thoughts.

[Belgarath]

No takers? I'm sure my hypothetical numbers are ridiculous, but I just want to see if I've got the basic concept. Plus, is there another more "reasonable" method for a first year situation than using the first year valuation method? 'Cause you technically don't usually know how the first year valuation will turn out until after the fact...

Thanks.