IRS Issues a Spate of New ESOP Rulings

The IRS issued a number of new rulings in the last few months, a few of which were significant.

In Revenue Ruling 96-30, the IRS ruled that a corporate spin-off of a subsidiary for the purpose of allowing the employees of that subsidiary to become owners of the subsidiary's stock under an ESOP was a valid business purpose, thus qualifying the transaction as a tax-free corporate transaction.

In a more significant ruling (PLR 9612034), the IRS allowed a company to break its ESOP into two pieces to facilitate a sale of a subsidiary. The company operated a leveraged ESOP for all its employees. It sold a subsidiary by breaking the ESOP into two ESOPs, one for the company and one for the subsidiary to be sold. Then it allocated a pro-rate share of the stock and remaining loan to the subsidiary, which repaid its piece of the remaining loan through the sale of the unallocated shares. The excess was allocated to employee accounts. The IRS approved this approach, but said the excess amounts would count as contributions under section 415 allocation limits, leaving unclear what would happen if these amounts exceeded the section 415 limits.

In a peculiar ruling (TAM 9624002), the IRS allowed an employer to terminate an ESOP and pay off the loan through the sale or unallocated shares. What was odd was the conclusion that two sons of the seller, who were allocated 10% of the stock, were deemed not to violate the prohibited allocation rules of section 409(n) even though the seller took advantage of the section 1042 rollover. Normally, such an allocation would be prohibited because of their relationship to the seller.

Finally, in perhaps the most important ruling, in PLR 9625045 the IRS allowed a company to use the current market value of shares in a leveraged ESOP as the basis for calculating its contribution value under section 415. The company's stock value had declined sharply since the ESOP. ESOP contributions had been used to match employee 401(k) contributions, but if the contributions were calculated as equal to the cost of repaying principal on the loan, the company would not have been able to provide as high a match as it had promised.