IRS Allows Price Protection for S Corporation ESOPs

In Private Letter Ruling 200827008, the IRS ruled that floor price agreements for S corporation ESOPs do not count as a second class of stock, which would disqualify the S election. S corporation rules in general do not consider stock rights that are agreements to redeem stock at death, divorce, disability, or termination of employment as creating an additional class of stock. The ruling said that floor price protection fell into this exception.

Many ESOP companies have multiple ESOP transactions. In some companies, after the first purchase of shares, often 30% to 50%, a second transaction is done to buy more shares. Other companies that are 100% ESOP-owned do additional leveraged transactions to acquire other companies. In either case, the new debt taken on can lower the price of the shares already in the plan. To deal with this, many ESOP companies offer some kind of price protection for existing participants. Sometimes that is limited to people over a certain age and/or to people getting distributions in the next x number of years. A floor price is set, and the company makes up the difference, if any, when the distribution is made.