IRS Rules ESOP not Tax Qualified

The U.S. Tax Court upheld a decision by the Internal Revenue Service (IRS) that an employee stock ownership plan (ESOP) and its employee stock ownership trust (ESOT) are not qualified under the tax code.

Tax Court Judge David Laro asserted that the IRS was correct in deciding that the ESOP and ESOT plans of Michael C. Hollen’s dental firm did not qualify under tax code Sections 401(a) and 501(a) for the plan year ended on October 31, 1987, and for all plan years after that.

Laro explained that the IRS had four valid reasons for finding that the ESOP and ESOT were not qualified:

  • The ESOP had not been timely amended to include provisions required by several sections of the tax code. Those sections included 402(c)(4)(C) (eligible rollover distributions), 414(n)(2)(C) (definition of employee leasing), 414(q) (definition of highly compensated employee), 414(u) (special rules for veterans), and 415(c)(3)(D) (participants’ compensation).
  • Plan amendments that the ESOP adopted did not make the provisions effective as of the required effective dates. 
  • The ESOP did not follow the vesting schedule required by Section 411(a)(2)(B).
  • The ESOP also failed to use an “independent appraiser” to appraise employer securities as required by Section 401(a)(28)(C), the court said.

The case is Michael C. Hollen D.D.S. PC v. Commissioner, T.C., No. 19618-08R.