Management Corporation ESOP Rejected

In a case that could have implications for efforts to set up S ESOP Corporation management companies, a U.S. Court of Appeals for the Eighth Circuit found that a management corporation's ESOP did not meet the coverage requirements of ERISA and revoked the plan's qualification (Beals Brothers Management Corp. v. Commissioner, 8th Cir., No. 01-3922, 8/27/02). Beals Brothers Management Corporation was set up to manage Beals Brothers Manufacturing. In 1987, the management company set up an ESOP for its four employees. It then bought the stock of the manufacturing company and merged with it. The two companies maintained separate ESOPs, but the manufacturing company's plan received almost no contributions, while the management company's plan received more significant contributions. A tax court ruled that the plan failed to meet the minimum coverage requirements of ERISA. The court concluded that the ESOP set up by the four owners for the management company "used management fees...to fund its plan." This arrangement, it said, "seems contrary to the broad participation objective" of ERISA. The court found that the two companies were members of the same controlled group, and thus must treat all employees as employees of the same employer. The company argued it should be able to aggregate the two plans, but the court concluded that to do that "the proportion of qualifying employer securities to total plan assets" would have to be substantially the same.

While this case does not involve an S corporation ESOP, its structure is reminiscent of current proposals to use ESOP tax advantages primarily for a small group of managers in a company. The history of this case suggests the IRS and the tax courts will not look kindly on plans designed to subvert the broad participation rules of ERISA.