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A recent technical advice memorandum (TAM), TAM 200841042, examines how the Large & Mid-Size Business Division (LMSB) recently requested technical advice concerning whether ESOP stock distributions should be treated as cash distribution when they are put back to the Company.

  • A technical advice memorandum (TAM) is guidance provided on the request of the IRS in response to technical questions that arise during proceedings:

    A technical advice memorandum, or TAM, is guidance furnished by the Office of Chief Counsel upon the request of an IRS director or an area director, appeals, in response to technical or procedural questions that develop during a proceeding. A request for a TAM generally stems from an examination of a taxpayer's return, a consideration of a taxpayer's claim for a refund or credit, or any other matter involving a specific taxpayer under the jurisdiction of the territory manager or the area director, appeals. Technical Advice Memoranda are issued only on closed transactions and provide the interpretation of proper application of tax laws, tax treaties, regulations, revenue rulings or other precedents. The advice rendered represents a final determination of the position of the IRS, but only with respect to the specific issue in the specific case in which the advice is issued. Technical Advice Memoranda are generally made public after all information has been removed that could identify the taxpayer whose circumstances triggered a specific memorandum.

  • The Large & Mid-Size Business Division (LMSB) is a division of the IRS that "serves corporations, subchapter S corporations, and partnerships with assets greater than $10 million."

The LMSB's position was that since the participants intended to ultimately receive cash, the distributions should be treated as cash distributions:

In a supplemental memorandum dated May 1, 2007, submitted to us from LMSB, LMSB stated that it agreed that in form the Plan made stock distributions to participants. LMSB further stated that if the Plan itself had redeemed the participants' stock, then the Plan would have obviously distributed cash to the participants, and that the exercise of the put option to obtain cash after stock was distributed is no different. LMSB noted that participants intended all along to receive cash. LMSB stated that their position is that stock should not be considered issued to participants where it is immediately redeemed pursuant to a prearranged plan.

Ensuring that a distribution is treated as a stock distribution is necessary to be eligible for net unrealized appreciation (NUA) treatment.

The TAM concluded that ESOP stock distributions that are put to the owner of the company are indeed treated as stock distributions and not cash distributions and may be eligible for net unrealized appreciation (NUA) treatment.

Stock distributions from the Taxpayer's employee stock ownership plan to its participants should not be treated as "cash" distributions when participants exercise their put options and sell their shares back to the Taxpayer. Participants who receive stock distributions are entitled to exclude the net unrealized appreciation in accordance with Code section 402(e)(4).

TAM Analysis

  • Here are the facts of the specific case in question:

    • The company serves as its own stock registrar and transfer agent for shares inside and outside the ESOP.
    • The plan document provided for share distributions and a put option.
    • Upon termination, participants receive a 402(f) Tax Information Notice, a Request for Distribution Form, and an Election to Sell (Election to Exercise Put Option) Form:

      ESOP Form #1 informs participants that they are entitled to receive a distribution of the vested balance credited to their ESOP account and that this distribution will be paid in the form of shares of the Taxpayer's common stock in the manner elected on the back of the form (deferred distribution, lump sum distribution, or direct rollover). Form #1 provides that if participants elect to receive their benefits in a lump-sum distribution, they will receive a Taxpayer stock certificate for their shares issued in their individual names, unless they designate joint tenant ownership with right of survivorship. Form #1 also informs participants that they have the right to sell to the Taxpayer any shares they may receive. Form #1 further states that, if the participant wishes to sell some or all of his shares of Taxpayer stock immediately following distribution of such shares from the Plan, then he must sign ESOP Form #2 and return it to the Taxpayer's Retirement Department.

      Form #2 includes a statement to be signed by the participant in which he acknowledges the distribution of shares from the ESOP and notifies the Taxpayer that as of the date of the participant's distribution from the ESOP, he is exercising his right to sell (Put Option) shares of Taxpayer common stock to the Taxpayer.

    • When the company receives the completed distribution forms for a lump sum distribution with an immediate put to the company, it completes a Recipient's Disposition as Elected form and provides all three forms to the appropriate department so the stock certificates can be processed. After the certificates have been processed to properly record the transaction, a check is cut from the company to the participant and the shares become treasury shares.

  • (l) Employer securities defined

    For purposes of this section—

    (1) In general

    The term "employer securities" means common stock issued by the employer (or by a corporation which is a member of the same controlled group) which is readily tradable on an established securities market.

    (2) Special rule where there is no readily tradable common stock

    If there is no common stock which meets the requirements of paragraph (1), the term "employer securities" means common stock issued by the employer (or by a corporation which is a member of the same controlled group) having a combination of voting power and dividend rights equal to or in excess of—

    (A) that class of common stock of the employer (or of any other such corporation) having the greatest voting power, and

    (B) that class of common stock of the employer (or of any other such corporation) having the greatest dividend rights.

  • Put Option - IRC Section 409(h)(1) - Right to demand employer securities; put option - In general provides that a participant entitled to a distribution has a right to demand a distribution in the form of stock. If the stock is not readily tradable, the participant has a right to require that the employer repurchase the employer securities:

    (h) Right to demand employer securities; put option

    (1) In general

    A plan meets the requirements of this subsection if a participant who is entitled to a distribution from the plan—

    (A) has a right to demand that his benefits be distributed in the form of employer securities, and

    (B) if the employer securities are not readily tradable on an established market, has a right to require that the employer repurchase employer securities under a fair valuation formula.

  • Put Option - IRC Section 409(h)(4) - Right to demand employer securities; put option - Put option period provides that an employer will be deemed to satisfy the put option requirements if it provides a put option at least 60 days following the date of distribution and for an additional 60-day period in the following plan year.

    (h) Right to demand employer securities; put option

    (4) Put option period

    An employer shall be deemed to satisfy the requirements of paragraph (1)(B) if it provides a put option for a period of at least 60 days following the date of distribution of stock of the employer and, if the put option is not exercised within such 60-day period, for an additional period of at least 60 days in the following plan year (as provided in regulations promulgated by the Secretary).

  • Put Option - Treasury Regulation Section 54.4975-7(b)(10) - Other statutory exemptions – Put Option states that stock acquired with exempt loan proceeds must be subject to a put option if it is not publicly traded when distributed:

    Put option. A qualifying employer security acquired with the proceeds of an exempt loan by an ESOP after September 30, 1976, must be subject to a put option if it is not publicly traded when distributed or if it is subject to a trading limitation when distributed. For purposes of subparagraph (10), a "trading limitation" on a security is a restriction under any Federal or state securities law, any regulation thereunder, or an agreement, not prohibited by this paragraph (b), affecting the security which would make the security not as freely tradable as one not subject to such restriction. The put option must be exercisable only by a participant, by the participant's donees, or by a person (including an estate or its distributee) to whom the security passes by reason of a participant's death. (Under this subparagraph (10), participant means a participant and beneficiaries of the participant under the ESOP.) The put option must permit a participant to put the security to the employer. Under no circumstances may the put option bind the ESOP. However, it may grant the ESOP an option to assume the rights and obligations of the employer at the time that the put option is exercised. If it is known at the time a loan is made that Federal or state law will be violated by the employer's honoring such put option, the put option must permit the security to be put, in a manner consistent with such law, to a third party (e.g., an affiliate of the employer or a shareholder other than the ESOP) that has substantial net worth at the time the loan is made and whose net worth is reasonably expected to remain substantial.

  • Duration of put option—(i) General rule. A put option must be exercisable at least during a 15-month period which begins on the date the security subject to the put option is distributed by the ESOP.

  • Net Unrealized Appreication (NUA) - IRC Section Sec. 402(e)(4) - Taxability of beneficiary of employees' trust - Other rules applicable to exempt trusts - Net unrealized appreciation provides for the net unrealized appreciation (NUA) special tax benefits for the distribution of company stock from a qualified retirement plan if certain requirements are met.

    (4) Net unrealized appreciation

    (A) Amounts attributable to employee contributions

    For purposes of subsection (a) and section 72, in the case of a distribution other than a lump sum distribution, the amount actually distributed to any distributee from a trust described in subsection (a) shall not include any net unrealized appreciation in securities of the employer corporation attributable to amounts contributed by the employee (other than deductible employee contributions within the meaning of section 72
    (o)(5)
    ). This subparagraph shall not apply to a distribution to which subsection (c) applies.

    (B) Amounts attributable to employer contributions

    For purposes of subsection (a) and section 72, in the case of any lump sum distribution which includes securities of the employer corporation, there shall be excluded from gross income the net unrealized appreciation attributable to that part of the distribution which consists of securities of the employer corporation. In accordance with rules prescribed by the Secretary, a taxpayer may elect, on the return of tax on which a lump sum distribution is required to be included, not to have this subparagraph apply to such distribution.

    (C) Determination of amounts and adjustments

    For purposes of subparagraphs (A) and (B), net unrealized appreciation and the resulting adjustments to basis shall be determined in accordance with regulations prescribed by the Secretary.

    (D) Lump-sum distribution

    For purposes of this paragraph—

    (i) In general The term "lump-sum distribution" means the distribution or payment within one taxable year of the recipient of the balance to the credit of an employee which becomes payable to the recipient—

    (I) on account of the employee's death,

    (II) after the employee attains age 591/2,

    (III) on account of the employee's separation from service, or

    (IV) after the employee has become disabled (within the meaning of section 72 (m)(7)),

    from a trust which forms a part of a plan described in section 401 (a) and which is exempt from tax under section 501 or from a plan described in section 403 (a). Subclause (III) of this clause shall be applied only with respect to an individual who is an employee without regard to section 401 (c)(1), and subclause (IV) shall be applied only with respect to an employee within the meaning of section 401 (c)(1). For purposes of this clause, a distribution to two or more trusts shall be treated as a distribution to one recipient. For purposes of this paragraph, the balance to the credit of the employee does not include the accumulated deductible employee contributions under the plan (within the meaning of section 72 (o)(5)).

    (ii) Aggregation of certain trusts and plans For purposes of determining the balance to the credit of an employee under clause (i)—

    (I) all trusts which are part of a plan shall be treated as a single trust, all pension plans maintained by the employer shall be treated as a single plan, all profit-sharing plans maintained by the employer shall be treated as a single plan, and all stock bonus plans maintained by the employer shall be treated as a single plan, and

    (II) trusts which are not qualified trusts under section 401 (a) and annuity contracts which do not satisfy the requirements of section 404 (a)(2) shall not be taken into account.

    (iii) Community property laws The provisions of this paragraph shall be applied without regard to community property laws.

    (iv) Amounts subject to penalty This paragraph shall not apply to amounts described in subparagraph (A) of section 72 (m)(5) to the extent that section 72 (m)(5) applies to such amounts.

    (v) Balance to credit of employee not to include amounts payable under qualified domestic relations order For purposes of this paragraph, the balance to the credit of an employee shall not include any amount payable to an alternate payee under a qualified domestic relations order (within the meaning of section 414 (p)).

    (vi) Transfers to cost-of-living arrangement not treated as distribution For purposes of this paragraph, the balance to the credit of an employee under a defined contribution plan shall not include any amount transferred from such defined contribution plan to a qualified cost-of-living arrangement (within the meaning of section 415 (k)(2)) under a defined benefit plan.

    (vii) Lump-sum distributions of alternate payees If any distribution or payment of the balance to the credit of an employee would be treated as a lump-sum distribution, then, for purposes of this paragraph, the payment under a qualified domestic relations order (within the meaning of section 414(p)) of the balance to the credit of an alternate payee who is the spouse or former spouse of the employee shall be treated as a lump-sum distribution. For purposes of this clause, the balance to the credit of the alternate payee shall not include any amount payable to the employee.

    (E) Definitions relating to securities

    For purposes of this paragraph—

    (i) Securities The term "securities" means only shares of stock and bonds or debentures issued by a corporation with interest coupons or in registered form.

    (ii) Securities of the employer The term "securities of the employer corporation" includes securities of a parent or subsidiary corporation (as defined in subsections (e) and (f) of section 424) of the employer corporation.

  • Net Unrealized Appreication (NUA) - Treasury Regulation Section 1.402(a)-1(b) Taxability of beneficiary under a trust which meets the requirements of section 401(a) - Distributions including securities of the employer corporation provides additional net unrealized appreciation (NUA) guidance and examples.

  • IRS Revenue Ruling 81-158, 1981-1 C.B. 205 - Taxability of beneficiary under a trust which meets the requirements of section 401(a) provides that a profit sharing distribution occurs upon the delivery of stock certificates to a transfer agent with instructions to reissue them in the name of the distributee.

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