Ninth Circuit Allows Boise Cascade Tax Deduction for ESOP Distributions

In Boise Cascade Corp. v. U.S. (9th Cir., No. 01-36086, 5/20/03), the Ninth Circuit Court of Appeals ruled that Boise Cascade could take a tax deduction for distributions of convertible preferred stock from the company's ESOP. The issue dates back to 1989 when Boise Cascade transferred convertible preferred to the ESOP. As is always the case in the ESOP, the trustee was the sold legal owner. If the stock were transferred to another person than the trustee, it automatically converted to common. When a participant terminated, the vested convertible preferred was automatically redeemed. The company could choose to redeem the convertible preferred in cash or stock prior to actual distribution. All 1989 payments were in cash. Participants could then elect to take the distribution in cash or stock. Boise Cascade then filed an amended tax return asking to receive a refund for the amounts it believed it could take as a tax deduction for amounts distributed in cash to employees. The IRS disallowed it. A district court then ruled for the company, and the appeals court affirmed the ruling.

The court ruled that the redemption qualified as a refund under IRC Section 302(b) and thus was deductible as an ESOP dividend. Whether this ruling would apply in other applications of this theory at other companies is not clear. That section provides, among other things, that a payout of convertible preferred stock is a dividend as long as it does not result in a "meaningful reduction of the shareholder's proportionate interest in the corporation." It did not here, the court ruled, because the participants were not the owners, the trust was. At the time, participants were able to roll over the distributions into IRAs even though these distributions were considered dividends. That would no longer be the case. Companies would presumably (but would not be required to) give employees a choice of receiving the payout as a cash distribution as a dividend or a distribution in stock that could be rolled into an IRA (but would not be deductible to the company. The dividend would taxed as a dividend to the employee, not as a distribution.