Can professional corporation adopt ESOP?

[Guest John Nelson]

A professional corporation is considering establishing an ESOP. However, in our state (Cal.), shares of stock in a professional corporation may only be issued to licensed persons. This of course begs the question "Can a professional corporation have an ESOP?" since non-licensed employees would be participants under the ESOP and would, arguably, "own" shares of stock in the corporation. If the terms of the ESOP provide that only licensed persons may serve as trustee of the ESOP (reasoning that the shares are actually "owned" by the trustee, not the participants) and that distributions will only be made in cash (not stock) (corporation's articles restrict ownership to employees or 401(a) trust), does ESOP comply with this state law restriction?

[Kirk Maldonado]

See Miller v. Commissioner, 76 TC 433 (1981).

[RLL]

You should check with the California state licensing authority for the appropriate profession for its position on this. There are some states that permit the arrangement which you refer to.

Many years ago, the State Bar of California had a position that an employee trust could own stock of a California law corporation only if all trustees and all beneficiaries of the trust were licensed lawyers. This meant that non-professional employees could not participate in an ESOP of the law P.C. I don't know whether this has changed.

Note that the IRS non-discrimination regulations (relating to ESOPs) would likely prohibit coverage of only the professionals under an ESOP even if the non-professional employees were covered by a "comparable" non-ESOP qualified plan. But it would be possible to cover the professionals under a (non-ESOP) stock bonus plan, with a comparable profit sharing plan for the non-professionals.

By the way, the 1981 Miller case (referred to above) addressed a situation before IRC Section 409(h)(2) permitted involuntary cash distributions in the case of an "ownership restriction."