News & Information

 

FEATURED PRODUCT

Pension and Employee Benefits: Code, ERISA, & Regulations
This series provides an authoritative and comprehensive reference to the full text of benefits-related provisions of the Internal Revenue Code, the full text of ERISA, and related proposed and final regulations, as well as the official IRS and DOL preambles, and Committee Reports.

Learn More »

CCH® PENSION — 03/29/10

Payments by employer to redeem stock held by ESOP were not deductible as dividends

An employer could not deduct cash distribution redemptive dividends paid to participants under an employee stock ownership plan (ESOP), the U.S. Court of Appeals in St. Louis (CA-8) has ruled in Nestle Purina Petcare Co. v. Commissioner.

The taxpayer-employer established the ESOP in 1989. A trust held the ESOP's assets, primarily employer preferred stock. When a participant left the company, the participant was required to direct the ESOP to convert the value of the preferred stock allocated to his or her ESOP account into cash, shares of employer common stock, or a combination of both. If a participant elected cash, the trust could require that the employer purchase stock from it, paying the trust a "redemptive dividend." From the redemptive dividend, the trust could distribute to the participants a "cash distribution redemptive dividend" as part of the total cash distributed to a participant. The employer sought to deduct over $9 million (the value of the cash distribution redemptive dividend), arguing that such a deduction is allowed under Code Sec. 404(k)(1) or, alternatively, under Code Sec. 162(k)(2)(A)(iii). The Tax Court, in Ralston Purina Co. v. Commissioner, held for the Commissioner, ruling that the payments were not deductible as dividends.

Code Sec. 404(k)(1) provides a deduction for an "applicable dividend." However, Code Sec. 162(k)(1) bars a deduction under Code Sec. 404(k) for amounts paid to a corporation's ESOP trust in order to redeem shares of the corporation's stock. Code Sec. 162(k)(2)(A)(iii), however, provides that Code Sec. 162(k)(1) does not apply to any deduction for dividends paid (within the meaning of Code Sec. 561). The taxpayer claimed a deduction for dividends, arguing that it paid dividends within the meaning of Code Sec. 561, and thus met the requirements of Code Sec. 162(k)(2)(A)(iii). The appellate court disagreed. Because Code Sec. 404(k) does not provide for a deduction for dividends paid within the meaning of Code Sec. 561, the court held, the employer did not satisfy the exception in Code Sec. 162(k)(2)(A)(iii). Therefore, the appeals court affirmed the judgment of the tax court and ruled that the employer could not deduct its cash distribution redemptive dividends.

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

Visit our News Library to read more news stories.