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    S Corporation ESOP Traps for the Unwary
    S Corporation ESOP Traps for the Unwary
    S Corporation ESOP Traps for the Unwary
    Ebook75 pages1 hour

    S Corporation ESOP Traps for the Unwary

    By The National Center for Employee Ownership (NCEO)

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    About this ebook

    An employee stock ownership plan (ESOP) is a powerful tool that can greatly benefit both employees and their employer. When an ESOP owns an S corporation, it is partially or wholly exempt from federal income taxation (and possibly state taxation, depending on the state), making it an even more powerful tool in many cases. There are clearly many benefits, financial and otherwise, associated with the S corporation ESOP model. However, since there is rarely a free lunch in the tax law, there are also various traps for the unwary in administering an S corporation ESOP. This publication, written by leading experts, describes some of these potential minefields and provides possible solutions to keep your ESOP and your company out of harm's way.

    LanguageEnglish
    PublisherThe National Center for Employee Ownership (NCEO)
    Release dateJun 5, 2012
    ISBN9781932924954
    S Corporation ESOP Traps for the Unwary
    Author

    The National Center for Employee Ownership (NCEO)

    The National Center for Employee Ownership (NCEO) is a private, nonprofit membership and research organization that serves as the leading source of accurate, unbiased information on employee stock ownership plans (ESOPs), equity compensation plans such as stock options, and ownership culture.

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      Book preview

      S Corporation ESOP Traps for the Unwary - The National Center for Employee Ownership (NCEO)

      S Corporation ESOP Traps for the Unwary

      Paul Horn, Corey Rosen, and Nancy Dittmer

      An NCEO Issue Brief

      Published by the National Center for Employee Ownership at Smashwords

      Copyright © 2011 by the National Center for Employee Ownership

      This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. This publication should not be construed as legal advice. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

      Legal, accounting, and other rules affecting business often change. Before making decisions based on the information you find here or in any publication from any publisher, you should ascertain what changes might have occurred and what changes might be forthcoming. The NCEO’s Web site (including the members-only area) and newsletter for members provide regular updates on these changes. If you have any questions or concerns about a particular issue, check with your professional advisor or, if you are an NCEO member, call or email us.

      Copyright © 2011 by The National Center for Employee Ownership. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without prior written permission from the publisher.

      This book is available in print at www.nceo.org along with dozens of other publications.

      ISBN: 978-1-932924-95-4

      The National Center for Employee Ownership

      1736 Franklin Street, 8th Floor

      Oakland, CA 94612

      (510) 208-1300

      (510) 272-9510 (fax)

      Web site: www.nceo.org

      Email: customerservice@nceo.org

      Smashwords Edition License Notes

      This ebook is licensed for your personal enjoyment only. This ebook may not be resold or given away to other people. If you would like to share this book with another person, please purchase an additional copy for each recipient. If you’re reading this book and did not purchase it, or it was not purchased for your use only, then please return to Smashwords.com and purchase your own copy. Thank you for respecting the hard work of these authors.

      Contents

      Introduction

      Conversion to S Corporation Status

      Limits on S Corporation ESOP Redemptions

      Limits on S Corporation Classes of Stock

      Limits on 2% S Corporation Owners

      S Corporation Distributions

      Code Section 409(p) Anti-Abuse Rules

      Notes

      About the Authors

      Introduction

      The S corporation ESOP model is almost 15 years old, and like any teenager it can create both pride and concern in its parent, which in this case is the company ESOP sponsor. There are clearly many benefits, financial and otherwise, associated with the S corporation ESOP model. However, since there is rarely a free lunch in the tax law, there are also various traps for the unwary in administering an S corporation ESOP. This issue brief describes some of these potential minefields and provides possible solutions to keep your ESOP and your company out of harm’s way.

      The S corporation entity was created by the Internal Revenue Code (the Code) in 1958 with the adoption of Subchapter S to the Code. At that time, an S corporation could have only 10 shareholders; this limit is now up to 100 shareholders. Additional restrictions also apply to who an eligible shareholder can be. The Small Business Job Protection Act of 1996 allowed banks to elect S corporation status and also provided some relief from certain S corporation rules. A 2011 report¹ stated that about one-third of banks had elected S corporation status.

      There are now over 3 million reporting S corporations, and it is an extremely popular form of business organization. Its more recent cousin, the limited liability corporation (LLC), is a creature of state rather than federal law and was first recognized by Wyoming in 1977. There are about half as many LLCs as S corporations.²

      S corporations are a popular business model because they can provide greater liability protection than a sole proprietorship but still are taxed simply like a pass-through entity for federal income tax purposes, and thus treated much like a partnership. This means that S corporation shareholders are taxed on their proportionate ownership of annual corporation income, but there is no federal tax (and usually no state tax) at the corporate level (i.e., they are subject to single, not double, taxation).

      An S corporation still must file a federal tax return, file Form 1120-S (due 2½ months after the close of its tax year), and prepare Form K-1s for all shareholders showing their pro-rata share of the S corporation income reported on Form 1120-S (along with other information). The S corporation also may have to file a tax return in certain states or jurisdictions such as New York and New Jersey (e.g., where the state treats the S corporation like a C corporation), or it may have to pay a franchise fee (e.g., 1.5% of income in California), and shareholders may have to file individual returns in states where the S corporation does business (or the S corporation

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