Donation of S-Corporation Stock to a Municipality's Qualified Plan

[Guest SCUDDESLER]

A local municipality sponsors a defined benefit plan. The municipality has been advised by a partner of an international accounting firm that a third-party, i.e., an entity other than the municipality or any of its employees, may donate $1.5 million of nonvoting, S-corporation stock to the defined contribution plan. The donor is a minority shareholder in the corporation. It is expected that the shares of S-corporation stock will be redeemed within 3 years of the donation. I have two questions:

(1) Is it possible for an entity/individual other than the employer or employee to donate/contribute funds to the defined benefit plan?

(2) If such an entity/individual can make such a contribution, are there any other related issues that I need to consider.

Thank you.[Edited by SCUDDESLER on 08-31-2000 at 11:55 AM]

[IRC401]

1. I'll duck the issue whether the contribution is deductible.

2. IF the IRS treats the donation as a gift to the municipality followed by a contribution to the pension plan, the municipality is probably not an eligible S corp shareholder.

3. The pension plan will be subject to UBTI tax. (Because a trust is a separate legal entity, I don't know if IRC 115 will protect the trust from the UBTI tax. A 115 entity is not an eligible shareholder. The trust would need to claim 115 status for income tax purposes and 401(a) status for S corp pruposes but not 410(a) status for income tax purposes.)

Get an opinion letter and please e-mail me with the name of the accounting firm.

[Kirk Maldonado]

Have you verified that there aren't any prohibited transaction issues with this arrangement?

[Carol V. Calhoun]

There is actually a very old revenue ruling, Rev. Rul. 63-46, 1963-1 CB 85, which permits contributions by a party other than the employer or the employees.

You might look at Code § 170©(1) with regard to the deductibility of a contribution to a state or local government as a charitable contribution. And of course, the donor might also argue that the contribution was a business expense, if the intent was to promote the business' name or secure other business advantages.

As for prohibited transaction problems, the federal rules for governmental entities (under § 503) are looser than those for private entities under § 4975. A donation of stock would probably not violate § 503. However, if the stock could be recharacterized as debt, there might well be an issue.

The question of whether UBIT applies to a governmental plan is too complicated to go into here. (You'll have to wait until my book comes out. ) However, suffice it to say that the answer is a resounding, "maybe."

Finally, as always, you need to consult applicable state and local law to determine whether there is any problem with the arrangement.