409(p) Compliance Question

[SadieJane]

Regarding Code Section 409(p) “prohibited allocations.” An S Corp ESOP provides that HCEs who are disqualified persons for 409(p) purposes (or reasonably likely to become disqualified persons) are not eligible for the annual ESOP allocations. This helps the Plan with 409(p) compliance. Can the Plan Sponsor give an HCE affected by this provision a taxable bonus, in an amount equal to what would have been the ESOP allocation, without any effect on the 409(p) test? The Plan Sponsor could not provide for the allocation under a different qualified plan (it would be treated as an allocation under the ESOP, affecting the 409(p) test), but if it is a taxable bonus—no tax-deferral element at all—thinking it might have no impact on the 409(p) test. Thoughts?

[EBECatty]

I think it's fine as long as you make sure it doesn't fall under one of the definitions of synthetic equity and doesn't use a structure that would trigger the avoidance or evasion rules.