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Exclusion of ESOP Stock
(Posted April 16, 2002)
Question 158: Corporation X owns 51% of Corporation Y. The remaining 49% is held by an ESOP sponsored by Corporation Y for the benefit of Corporation Y's employees. Are X and Y in a controlled group for all tax purposes?
Answer: Let's move out gradually on possible tax purposes. We'll start with IRC 415(h). That section says that a parent-subsidiary group exists for 415 purposes if the parent owns more than 50% of the subsidiary. Obviously, that applies here.
Next we'll go to IRC 1563, the general section determining whether a controlled group exists. IRC 1563(c)(2)(A)(i) says that if a parent owns at least 50% of a subsidiary, then you exclude any stock held by a deferred compensation plan (qualified or not) for employees of either the parent or the subsidiary. The ESOP is just such a plan, and X meets the ownership requirement. Accordingly, the stock held by the ESOP is excluded. That means Corporation X owns 100% of the nonexcluded Corporation Y stock. Accordingly a parent-subsidiary controlled group exists.
Now we move to IRC 414(b), the pension section. The exclusion rules are used in determining controlled group status for retirement plan purposes. So, for qualified plan purposes, the two corporations are a controlled group.
I recently had someone else ask me this very question for purposes of IRC 332, which deals with liquidation of subsidiaries. However, IRC 332 does not refer to the controlled group rules. Instead, it refers to the affiliated group rules used in filing consolidated returns. To have an affiliated group under IRC 1504, the parent must own actually 80% of the subsidiary. There's no attribution other than an extremely limited version of option attribution, and no exclusion rules other than exclusion of nonvoting preferred nonconvertible stock. Thus, the controlled group rules are not applicable to IRC 332 situations.
The exclusion rules are among the most complex of the controlled group area. I have devoted Chapter 8 of my book Who's the Employer to explaining and illustrating these rules.
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