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5500 Preparer's Manual for 2012 Plan Years
The premier resource in the field of Form 5500 preparation, 5500 Preparer's Manual will help you handle the required annual Form 5500 filings for both pension benefits and welfare benefit plans.
The IRS has issued final regulations on the requirements under Code Sec. 409(p) for employee stock ownership plans (ESOPs) holding stock of Subchapter S corporations.
Code Sec. 409(p)(1) requires that, for ESOPs holding employer securities consisting of stock in an S corporation during an allocation year, no portion of the assets of the plan attributable to the employer securities may accrue for the benefit of any disqualified person. Generally, a disqualified person, under Code Sec. 409(p)(4), is any person whose deemed-owned ESOP shares are at least 10% (or 20% when that owned by his family is included) of the number of deemed-owned shares of S corporation stock held by the ESOP. Any plan year during which disqualified persons are deemed to own at least 50% of the shares of the S corporation is a nonallocation year, according to Code Sec. 409(p)(3)(A).
The IRS previously issued temporary and proposed regulations on the subject in 2003. After a public hearing, new temporary and proposed regulations were issued in 2004. After another public hearing, these final regulations were issued. The regulations are effective December 20, 2006 and generally apply to plan years beginning on or after January 1, 2006. However, the 2004 regulations remain applicable to plan years beginning before January 1, 2006.
The final regulations retain the rule of the 2004 temporary regulations concerning prohibited allocations under which there is an impermissible accrual to the extent employer securities consisting of S corporation stock are held under the ESOP for the benefit of a disqualified person during a nonallocation year. Thus, in the event of a nonallocation year, S corporation shares held in a disqualified person's account and all other ESOP assets attributable to S corporation stock, including distributions, sales proceeds, and earnings, are treated as an impermissible accrual whether attributable to contributions in the current year or a prior year. If there is a prohibited allocation during a nonallocation year, the ESOP fails to satisfy the requirements of Code Sec. 4975(e)(7) and ceases to be an ESOP. The final regulations further clarify that the plan would also fail to satisfy the qualification requirements under Code Sec. 401(a) by not operating the plan in accordance with its terms and the S corporation would be subject to excise tax under Code Sec. 4979A.
A plan might employ certain methods to prevent the occurrence of a nonallocation year. Any method of preventing a nonallocation year must satisfy applicable legal and qualification requirements, including the nondiscrimination requirements of Code Sec. 401(a)(4) (including the rules at Reg. §1.401(a)(4)-4 relating to benefits, rights and features), and implementation of these methods must be completed before a nonallocation year occurs.
One method of preventing the occurrence of a nonallocation year is the transfer method, under which S corporation securities held for the participant under the ESOP are transferred into a separate portion of the plan that is not an ESOP or to another qualified plan of the employer that is not an ESOP. The final regulations retain the rule in the 2004 regulations for applying the nondiscrimination requirements for a plan that uses the transfer method. Thus, if a transfer is made from an ESOP to a separate portion of the plan (or to another qualified plan of the employer) that is not an ESOP in order to prevent a nonallocation year, then both the ESOP and the plan that is not an ESOP will not fail to satisfy the requirements of Reg. §1.401(a)(4)-4 merely because of the transfer.
The final regulations generally retain the attribution rules included in the 2004 regulations. Thus, the Code Sec. 318 attribution rules are applied to ownership of synthetic equity in determining who is a disqualified person. The final regulations also clarify the rules for treating family members as disqualified persons and modify the examples accordingly.
Under Code Sec. 409(p), synthetic equity is defined as any stock option, warrant, restricted stock, deferred issuance stock right or similar interest or right that gives the holder the right to acquire or receive stock of the S corporation in the future. For purposes of determining a nonallocation year and disqualified persons, if a person owns synthetic equity in the S corporation, then the shares of stock in such corporation on which such synthetic equity is based will be treated as outstanding stock in such corporation and deemed-owned shares of such person if such treatment of synthetic equity of one or more persons results in the treatment of any person as a disqualified person or the treatment of any year as a nonallocation year. The final regulations follow the rules for synthetic equity that were set forth in the 2003 and the 2004 regulations. Thus, the person who is entitled to the synthetic equity is treated as owning a number of shares of stock in the S corporation equal to the present value of the synthetic equity divided by the fair market value of a share of the S corporation's stock as of the same date. The final regulations also retain the triennial method set forth in the 2004 regulations that permits the ESOP to treat the number of synthetic equity shares owned on a determination date as remaining constant for a three-year period.
For more information on this and related topics, consult the CCH Pension Plan Guide.
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