IRS Drops New Attribution Rules for S ESOP Anti-Abuse Test

One of the most confusing and controversial aspects of the proposed rules for anti-abuse testing on S corporation ESOPs (Temporary and Proposed Treasury Regulation Section 1.409(p)-1 T) concerned the combination of the family attribution rules under existing tax law with the specific tests for family ownership in the S ESOP rules (essentially that family members were limited to 20% of the synthetic equity plus ESOP allocations to avoid testing under the disqualified person rules). The combination could make the 20% test meaningless because individuals are limited to 10% of the synthetic equity plus ESOP allocations, and if the attribution rules applied, family members' ownership could bring an individual above this individual 10% limit, even if it were below the 20% family limit.

In response to concerns expressed by practitioners and Employee-Owned S Corporations of America (an organization of S corporations with ESOPs), among others, the IRS has agreed to simply drop this paragraph.