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CCH® PENSION — 02/08/11

Tax court upholds disqualification of professional corporation ESOP

A professional corporation's employee stock ownership plan (ESOP) and its related trust were not qualified because the plan was not timely amended to reflect legislative changes to the plan qualification requirements, the U.S. Tax Court has ruled. In addition, the ESOP failed to follow the required vesting schedule, failed to use an independent appraiser to appraise employer securities held by the trust, and the beneficiary account of the principal shareholder exceeded the allowable amount of annual additions.

A professional corporation began sponsoring an ESOP in 1987. On January 1, 2001, the ESOP was amended, effective as of that date. In December 2002, a determination was requested as to the qualified status of the ESOP. The request was subsequently withdrawn in 2003. In 2008, the Commissioner issued a final determination letter disqualifying the ESOP and this action ensued. The Tax Court in Michael C. Hollen, D.D.S. P.C. v. Commissioner upheld the Commissioner's determination.

First, the court ruled that the ESOP was not amended to reflect the qualification changes made by the Small Business Job Protection Act of 1996 (P.L. 104-188) and the IRS Restructuring and Reform Act of 1998 (P.L. 105-206). Although the plan was amended to include required provisions before the remedial amendment period expired, the amendments were still not timely, the court ruled, because they failed to make the provisions effective as of their required effective dates.

Second, the court ruled that the ESOP did not operationally satisfy the vesting requirements of Code Sec. 411 because the plan did not follow the vesting schedule required by law and set forth in the plan document. Moreover, the ESOP did not participate in a closing agreement program (CAP) that would have allowed for retroactive compliance.

Third, the corporation's nonpublicly traded stock, which was held by the ESOP trust and appraised by the corporation's accountant, was not valued by a qualified appraiser as required by Code Sec. 401(a)(28)(C) because the required appraiser declaration in the appraisal letters was not signed and the appraisal summary did not list the appraiser's background information.

Finally, the court held that the IRS did not abuse its discretion by recharacterizing part of a dividend on employer stock distributed to the ESOP as an annual addition to a participant's account, which resulted in the annual addition exceeding the Code Sec. 415 limit.

For more information, visit http://www.wolterskluwerlb.com/rbcs.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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