Deduction for ESOP distributions disallowed.

• Author: Beavers, James

[ILLUSTRATION OMITTED]

In a decision that creates a circuit split, the Eighth Circuit reversed a district court and held that a corporation was not entitled to a deduction for cash distribution redemptive dividends paid by the corporation's employee stock ownership plans to plan participants who left the corporation.

Background

General Mills, Inc. (GMI) established three employee stock ownership plans (ESOPs). A single trust (the trust) held the ESOPs' assets, primarily GMI common stock. GMI contributed to the ESOPs for the benefit of participating employees.

When a participant left GMI, the trust distributed, in cash or stock, the value of the participant's ESOP account. If a participant elected cash, the trust could request that GMI purchase company stock from the trust, paying the trust a dividend known as a redemptive dividend. From the redemptive dividend, the trust could distribute a cash distribution redemptive dividend (CDRD) as part of the total cash distributed to the participant.

GMI sued for a refund equal to the value of deductions for its CDRDs (almost $5 million), arguing that Sec. 404(k)(1) allowed a deduction for them. The IRS countered that Sec. 162(k)(1) or, alternatively, Sec. 404(k)(5) barred any deduction allowed by Sec. 404(k)(1).

The Deduction for Applicable Dividends

Sec. 404(k)(1) allows as "a deduction for a taxable year the amount of any applicable dividend paid in cash by such corporation with respect to applicable employer securities." An applicable dividend includes "any dividend which, in accordance with the plan provisions ... is paid to the plan and is distributed in cash to participants in the plan or their beneficiaries not later than 90 days after the close of the plan year in which paid" (See. 404(k) (2)(A)(ii)). The corporation may claim the deduction only for a tax year in which the participant receives cash (See. 404(k)(4)).

Payments by a corporation to participants (such as those made by GMI), routed through a trust, are applicable dividends under Sec. 404(k)(2)(A)(ii). The corporation, not the trust, is the entity ("such corporation") claiming the Sec. 404(k)(1) deduction. The corporation's payment of the redemptive dividend to the trust does not by itself qualify for a Sec. 404(k)(1) deduction (nor does an independently funded cash distribution by the trust to a participant). Thus, the Sec. 404(k)(2)(A) (ii) transaction is a two-step process.

The District Court's Holding

The issue before the...