Sub-S corp, put option and 409(h)

[t.haley]

ESOP established in 2002, non-publicly traded stock. Corporation elected sub-s status in 2008. I understand that Code 409(h) excepts ESOPs maintained by sub-s corporation from the put option requirement. But must the plan document contain language to that effect? Currently the plan document contains the required put option language but does not contain any language referencing 409(h) in the event the corporation elects sub-s status. Corporation is considering terminating the ESOP and wants to know if they can make distributions in stock without having to deal with put options.

[QDROphile]

The plan document should always accurately specify how the plan operates, preferably with more than a simple reference to the Internal Revenue Code or regulations.* If plan terms are more restrictive than the Code allows (but not inconsistent with the Code), the restrictions are effective.

*With respect to many formal requirements, especially for ESOPs, a mere reference to compliance with a particular Code provision is legally inadequate for qualification

[t.haley]

QDROphile - that's what I was thinking also. Could the plan be amended prospectively (to only apply to distributions made after 1-1-16 for calendar year plan) to add language that in the event the corporation elects sub-s status, the provisions of 409(h) would apply and the put option would not be required?

[RLL]

An S Corp ESOP is not exempted from the put option requirement. It is exempt from the requirement that distributees have a right to demand distributions in the form of employer stock and may provide that any stock distributed is subject to an immediate buyback by the employer.

[ESOP Guy]

A little off topic and this might have been thought of but....

If you give everyone stock will you still have under 100 (I think that is the number) shareholders?

An S Corp has a max number (think 100) shareholders.

I agree with RLL S Corps have the Put Option requirement. It is just people can't demand stock and keep it otherwise large S Corp ESOP companies could go over the stockholder max limit if enough people demand stock and keep it. In other words S Corps can have a mandatory Put Option upon distribution of the stock-- ie the person HAS to sell the stock.

[Griswold]

Just to add, another reason for the exception--often participants want to roll their allocated shares into an IRA. However, IRAs are not eligible to own shares of an S-Corp. and so, such a rollover might jeopardize the S election.

[t.haley]

Thanks for the replies. The employer is in an odd situatuion. The plan has been frozen since 2010 and they are wondering if it would be best to terminate the plan instead of incurring the costs to maintain the plan. They want to avoid making cash distributions or being required to buy back stock distributed under the put option due to lack of cash. In essence, they want to make all stock distributions upon termination of the plan and not be subject to a put option due to lack of funds. There are very few participants in this plan so we don't really have a problem with going over the max number for a sub-s corporation. I am trying to explore all possible solutions for them. At this point, it may just be best to continue the plan and pay out the participants as they retire or terminate employment.

[Griswold]

If the stock is put back to the company you might be able to spread the payments out over five years.

[GMK]

If the stock is put back to the company you might be able to spread the payments out over five years.

Just curious, is this allowed for payments to Participants who are still employed by the Employer?

[Griswold]

GMK - I've seen it done, though I don't know of the authority for it off the top of my head.