S Corporation Rules Involving Section 409(p)

Section 409(P) of the Code, which was enacted as part of the Economic Growth and Tax Relief reconciliation Act of 2001, sets forth anti-abuse rules for ESOPs that are maintained by S corporations.  The following is to summarize the restrictions of Section 409(P), as follows: Basic Rule:  No assets of an ESOP may be allocated (directly or indirectly) for the benefit of any Disqualified Person if, at any time during the plan year, Disqualified Persons, in the aggregate, own 50% or more of the equity of an S corporation.  Thus, the test can be broken down into two steps:  Step One — identifying the Disqualified Persons, and Step 2 — determining whether they own at least 50% of the equity. Consequences:  If an S corporation ESOP fails this test, then the result is a Non-allocation Year. If a Non-allocation Year occurs, then the plan loses its exemption from the unrelated ... Read More..

ESOP: A New Tax Savings Tool for Owners of S Corporations

“A new dawn greets ESOP companies!” “The Holy Grail of business opportunities beckons: ESOP companies can now operate tax free!” Not since 1984, when the §1042 tax-free rollover was enacted, has the ESOP community bubbled with such enthusiasm. Under the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, (“EGTRRA”), the ESOP’s share of S corporation earnings will not be subject to federal corporate taxation or to taxation as “unrelated business income tax,” unless the ESOP runs afoul of certain “anti-abuse” provisions. Thus, in the case of an S corporation that is 100% owned by its ESOP, the company’s earnings will be entirely tax exempt. Even the least ebullient of practitioners note that fiduciaries of existing ESOPs now confront a new obligation: to assess whether electing S status would benefit the company and the trust beneficiaries. A Bit of History Until the Small Business Job Protection Act ... Read More..

New Law on S-ESOP Prohibited Allocations

MEMORANDUM From: Legal Department Date: January 2008 Subject: Prohibited Allocations in S Corp ESOPs Section 409(p) of the Code, which was enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001, sets forth anti-abuse rules for ESOPs that are maintained by S corporations. The following is to summarize the restrictions of Section 409(p), as follows: Basic Rule: No assets of an ESOP may be allocated (directly or indirectly) for the benefit of any Disqualified Person if, at any time during the plan year, Disqualified Persons, in the aggregate, own 50% or more of the equity of an S corporation. Thus, the test can be broken down into two steps: Step 1— identifying the Disqualified Persons, and Step 2— determining whether they own at least 50% of the equity. Consequences: If an S corporation ESOP fails this test, then the result is a Nonallocation Year. If a Nonallocation ... Read More..

Economic Growth and Tax Relief Reconciliation Act of 2001

Comparison of Old and New Provisions Current Law New Law (EGTRRA) I.  Increases in Contribution, Deduction and Benefit Limits Contribution Deduction Limits: An employer’s deduction for contributions (including 401(k) deferral contributions) to a profit sharing or stock bonus plan is limited to 15% of participants’ taxable compensation. The money purchase plan limit is 25%. The 15% deduction limit is increased to 25%. 401(k) deferrals do not count against the limit. Compensation used to determine deductions   includes deferrals. Money purchase plan limit remains at 25%. Effective: Employer’s taxable years beginning after December 31, 2001 Individual Benefit and Contribution Limits: Allocations of employer and employee contributions and forfeitures in a profit sharing, 401(k) or other defined contribution plan cannot be greater than the lesser of (i) 25% of gross pay or (ii) $35,000 (indexed). Allocations of employer and employee contributions and forfeitures cannot be greater than the lesser of (i) 100% of gross pay or (ii) $40,000 (indexed). Effective: Limitation years beginning after December 31, 2001 Annual Compensation: Currently a ... Read More..