IRS Allows Transitory Distribution to IRA in an S Corporation ESOP

An unpublished IRS private letter ruling has concluded that an S corporation ESOP can make a distribution of company stock to a participant's Individual Retirement Account (IRA) without breaking the S election. S corporation rules prohibit an IRA from owning company stock, but practitioners have argued that if the IRA immediately resells the distributed stock to the company or the ESOP, then it cannot practically be considered to have owned the shares. By allowing this kind of transaction, practitioners have argued, the IRS would save the extra hassle of distributing stock to the employees, which would then be sold back to the company or ESOP, with the proceeds put into the IRA.

The IRS has agreed with this argument, concluding that no useful tax purpose is met by requiring the extra step. Companies will have to monitor their distributions, however, so that no more are made on any one day than would be required to stay under the 75 shareholder limit for S corporations.