New IRS Ruling Regarding Taxation of ESOP Distributions discusses technical advice memorandum (TAM) 200841042, which we discussed last October in TAM: ESOP Stock Distributions Subject to Immediate Put Option to Company are Indeed Stock Distributions Eligible for Net Unrealized Appreciation (NUA). This TAM involved a local IRS office that took the position that share distributions immediately put to the company should be considered cash distributions, causing the distributions to be ineligible for net unrealized appreciation (NUA) treatment. The article discusses how the national office overruled the position:
The national office rejected the local office's position, and ruled that the stock distributions from the company's ESOP to the participants should not be treated as cash distributions when the participants exercised their put options and sold their shares immediately back to the company. The national office noted that there is nothing in the law that either prevents participants who have received a distribution of employer stock from immediately exercising their put options or prevents plan sponsors from immediately buying the stock with respect to which the options have been exercised.
Similarly, the national office noted that there was nothing in the law that prohibited participants from providing instructions for the exercise of their put options in advance of receiving a distribution of their stock. In this regard, the national office noted that "inherent in the concept of the put option under Code section 409(h) is the participant's intention to obtain cash and that the immediate sale of stock pursuant to a prearranged plan is consistent with the statutory and regulatory provisions concerning put options." Therefore, the national office ruled that stock distributed from the ESOP should not be treated as cash when it is sold back to the plan sponsor. The national office went on to state that the participants could exclude net unrealized appreciation from their taxable income under the rules applicable to distributions of employer securities.
This Technical Advice Memorandum is important because many companies that sponsor ESOPs allow or require terminated participants who receive their distributions in the form of company stock to sell that stock back to the company immediately. If the national office had upheld the position taken by the local office, ESOP companies that allowed for ESOP benefits to be paid in the form of company stock would be required to issue share certificates to the participants even in situations where the participants elect or are required.