Plan year change?

[Belgarath]

Just wondering - say a C-corp with a fiscal year, and an existing leveraged ESOP, decides to switch to S-corp status and change their fiscal year to calendar year.

Pros and cons of changing ESOP plan year to match the new fiscal year and running a short plan year? Any special problems (or advantages) that you've seen one way or the other?

[A Shot in the Dark]

I think the plan year should switch with with fiscal year change, if for no other reason than future appraisal and valuation issues.

I could see a lot of complexities with completing corporate financials and said reporting for a an appraisal not tied to the fiscal year end.

I think all of the plan accounting would be easier.

The negatives would be

• the "one time" appraisal issue
• say you have a C corp with a June 30th fye and the "S" corp with a calendar year end
• as an example for the 2014 year, an appraisal would be required for the valuation date June 30, 2014 and then another appraisal would be due as of December 31, 2014
• the administrative and recordkeeping costs for the short plan year

You did not mention If the plan requires a plan audit which would add costs.

For the most part, I think it is worth the additional costs attributable to the short plan year relative to future burden of reporting, etc.

[Marcus R Piquet]

Some do not realize that if the ESOP owns 100% of the outstanding shares it is not necessary for the sponsor to change to a calendar year end. It is permitted to retain the year end of its sole shareholder. This only works in a 100% ESOP ownership scenario.

[Belgarath]

Thanks!! This is really helpful information.

"Some" certainly includes me - I did not know this. (Never had any reason to check, either)

Do you perhaps have a reference or citation that states this - regulation, IRS publication, etc.?

(Something that specifically refers to a 100% ESOP owned S-corp, or is this just done under a general or valid business purpose, etc., on a from 2553, or 444, or whatever?)

[Marcus R Piquet]

See Rev. Proc. 2006-46.

One of the automatically-approved tax years for an S Corporation (under the "sufficient business purpose" category is the "ownership taxable year."

Section 5.06 of the Rev Proc defines a Permitted Taxable Year as 1) the required taxable year (i.e., December 31); 2) a natural business year, 3) the ownership taxable year; 4) a tax year elected under §444 (i.e., September, October, or November, with an annual deposit requirement); or 5) any other taxable year for which the taxpayer establishes a business purpose to the satisfaction of the Commissioner.

Section 5.08 of the Rev Proc defines an Ownership Taxable Year as follows:

For an S corporation or electing S corporation, an "ownership taxable year" is the taxable year (if any) that, as of the first day of the first effective year, constitutes the taxable year of one or more shareholders (including any shareholder that concurrently changes to such taxable year) holding more than 50-percent of the corporation's issued and outstanding shares of stock. Under principles similar to §1.706-1(b)(5) for determining the taxable year of a partnership, a shareholder that is tax-exempt under §501(a) is disregarded if such shareholder is not subject to tax on any income attributable to the S corporation. Tax-exempt shareholders are not disregarded, however, if the S corporation is wholly-owned by such tax-exempt entities.

An ESOP is a tax-exempt entity under §501(a). If it owns anything less than 100%, its ownership is disregarded for purposes of defining the ownership tax year. However, if it owns 100%, then its ownership is not disregarded. The S corporation can therefore retain the ESOP's tax year end, no matter what month that is. No annual deposit under §444 is required.

We have dozens of S Corp ESOP clients with non-calendar year ends under this provision, so I know it works. One word of caution. In almost 50% of the cases that we've done this, the IRS does not correctly process the Form 2553 and automatically assigns a Calendar year end. This is a simple oversight on their end since the use of this provision is so extremely rare in their eyes. In all cases I've been able to simply place a call to the entities division in Ogden and have the situation corrected over the phone, with a corrected notice sent to the client shortly thereafter indicating the desired year end.

Good luck!

Marcus

[ESOP Guy]

Remember a short plan year can create an "extra" year of service for vesting and participation for diversification counts. Not tragic but worth taking note of when you do it. You might have a few people diversifying earlier then you thought and vesting a little earlier then you though.