IRS Issues Settlement Procedure for Abusive ESOP S Corporations

In Announcement 2005-80, the IRS set out the details of a proposed settlement procedure for a number of improper transactions, including three abusive applications of S ESOP rules. People who claimed a tax benefit from the transactions (but not promoters and their relatives, people in litigation over the transaction, or people where fraud or criminal investigations or settlements are involved) can apply. If the settlement is concluded, the taxpayers will only have to pay a 5% penalty, not a 20% penalty. They will, however, be responsible for all taxes due, plus interest. Their ESOP plan and/or S election could be terminated, causing further tax complications. Additional payments for improper calculation of basis, excise taxes, and/or employment taxes may be due once the transaction is undone.

The three abusive applications include management S corporations (those where all or almost all the benefits were structured to go to management), "Q Sub" structures (those funneling most or all profits to specially set up subsidiaries to benefit a small number of people), and transactions described in Revenue Rulings 2003-6 and 2003-1 C.B. 286 that applied to attempts to extend the grandfather date for transactions not meeting the requirements imposed by the anti-abuse rules.