IRS Publishes Sample 409(p) Language

The Internal Revenue Service has published sample plan language to prevent violation of the Section 409(p) S ESOP corporation anti-abuse rules that prevent disqualified persons from ending up with more than 49.9% of the total deemed-owned shares of the company. One common way to avoid severe tax penalties from a violation of 409(p) is to move stock held in the ESOP portion of the account into a segregated non-ESOP portion, where it would be subject to unrelated business income tax. To accomplish this, the model language states, in part, that:

"A nonallocation event occurs only if (i) the total number of shares of employer stock that, held in the ESOP account of those Participants who are or who would be disqualified persons after taking into account the Participant's synthetic equity and the nonallocation event, exceeds (ii) 49.9% of the total number of shares of employer stock outstanding after taking the nonallocation event into account (causing a nonallocation year to occur as described in Section xxx of the Plan). No transfer under this section shall be greater than the excess, if any, of (i) over (ii). Before the nonallocation event occurs, the Plan Administrator shall determine the extent to which a transfer is required to be made and shall take steps to ensure that all action necessary to implement the transfer are taken before the nonallocation event occurs."

The ESOP Association, in comments on the language, noted that it seemed to require that the Plan Administrator effect a transfer that would result in exactly 49.9% of the of total number of shares ending up in the hands of disqualified persons. This would be impractical most of the time. In any event, the IRS would be better off if more were transferred to the segregated accounts because it would be subject to taxation. The Association suggested that the language be changed so say that the transfer could be no less than the excess of (i) over (ii).

Other parts of the suggested plan language deal with the order of the transfers, taking shares first from those with the largest number of ESOP and deemed-owned shares. An IRS spokesman told BNA that the language was simply sample language that would automatically pass a compliance test; it did not preclude other approaches.