The IRS recently issued guidance alerting business owners and tax professionals about abusive tax schemes relating to employee stock ownership plans (ESOPs).
An ESOP is a type of tax-qualified retirement plan that permits employees to own stock in their employer’s company.
While ESOPs can be extremely powerful and useful, for several reasons, IRS Commissioner Danny Werfel said, “Businesses and individual taxpayers should seek advice from an independent and trusted tax professional instead of promoters focused on marketing questionable transactions that could lead to bigger trouble.”
The IRS reported that it has seen schemes where a business creates a “management” S corporation whose stock is wholly owned by an ESOP for the sole purpose of diverting taxable business income to the ESOP. The S corporation purports to provide loans to the business owners in the amount of the business income to avoid taxation of that income. The IRS disagrees with how taxpayers interpret this transaction and emphasizes that these purported loans should be taxable income to the business owners. These transactions also impact whether the ESOP satisfies several tax law requirements which could result in the management company losing its S corporation status.
Employers that utilize ESOPs should consult with their ERISA counsel to ensure that they are complying with the unique rules that apply to ESOPs.
Moreover, when it comes to tax ideas relating to benefit plans in general (see our posts relating to IRS guidance on indemnity plans), ERISA counsel can help separate the good ideas from those that might be too good to be true.