Plan distributions from SESOPs.

• Author: O'Connell, Frank J., Jr.
• Position: Employee stock ownership plan seeking to roll over distributions of S corporation stock into individual retirement accounts

Rev. Proc. 2003-23 addresses the practical problem of employee stock ownership plan (ESOP) participants seeking to roll over distributions of S corporation stock into an individual retirement account (IRA), when the trustee or custodian of such an account is not a permissible S shareholder.

Background

In 1996, Congress amended the Code to make ESOPs, along with other qualified retirement plans, eligible S shareholders. Since then, hundreds of ESOP sponsors have examined whether they would qualify for an S election and potentially benefit from becoming an S corporation. Among those electing S status, many have also increased the percentage of S stock held to 100%.

An ESOP is unique because, in addition to functioning as a qualified retirement plan, it also provides participants with equity ownership in the corporation. This equity-ownership arrangement applies to both C and S corporation that sponsor ESOPs.

Distribution Problems

Generally, ESOP plans have to allow participants to receive distributions as employer securities when they become entitled to a distribution under the plan's terms. However, an S corporation ESOP (SESOP) can distribute only cash or employer securities subject to a repurchase requirement (also known as a "put option").

Qualified plans (including ESOPs) permit participants receiving an eligible rollover distribution to roll it over directly to an eligible retirement plan, including an IRA. Thus, a problem arises; the IRA trustee or custodian is not a permissible S shareholder.

Under Sec. 409(h)(2)(B), a SESOP plan providing for distributions of SESOP securities can require the S corporation to immediately repurchase the S stock included in...