SESOP May Repurchase Stock Distributed in IRA Rollover

The Service recently modified Rev. Proc. 2003-23, by permitting an S corporation employee stock ownership plan (SESOP) to assume the corporations rights and obligations to repurchase the corporations stock that the SESOP distributes to a participants IRA.

Analysis

A SESOP that holds S stock and permits distributions of employer securities must permit participants to elect to have any eligible rollover distribution of S stock be paid directly to an eligible retirement plan, including an IRA. An IRA trustee or custodian, however, is not a permissible S shareholder; see Sec. 1361(b) and (c)(6).

Under Sec. 409(h)(2)(B), a SESOP that provides for distributions of securities can provide that the S stock included in the distribution is subject to a repurchase requirement. Thus, a SESOP can provide that any distributed S stock is subject to immediate repurchase by the S corporation on a direct rollover of the stock from the SESOP to an IRA. If the following requirements are satisfied, the Service will accept the position that the distribution does not affect the S corporations election to be taxed as an S corporation:

• The SESOPs terms require that the S corporation repurchase the stock immediately on the SESOPs stock distribution to an IRA;

• Under the SESOPs terms, (1) the S corporation actually repurchases the stock contemporaneously with, and effective on the same day as, the distribution or (2) the SESOP is permitted to assume the S corporations rights and obligations to repurchase the stock immediately on the SESOPs distribution of the stock to an IRA, and the SESOP actually repurchases it contemporaneously with, and effective on the same day as, the distribution; and

• No income (including tax-exempt income), loss, deduction or credit attributable to the distributed S stock under Sec. 1366 is allocated to the participants IRA.

Rev. Proc. 2004-14, IRB 2004-7, 489

Reflections: All of the requirements for allowing a direct rollover of S stock to the participants IRA were originally set forth in Rev. Proc. 2003-23, except for the modification permitting the SESOP to assume the employers repurchase rights.