IRS Warns Plan Sponsors of ESOP Compliance Risks

The Internal Revenue Service (IRS) issued IR-2023-144 (“IRS Notice”) on August 29, 2023, which concerns Employee Stock Ownership Plans (ESOPs). These plans allow employees to accrue ownership of company stock over time. The IRS Notice warns employers who sponsor ESOPs to be wary of the many compliance rules that these plans involve. In particular, the IRS expresses concern in its Notice that some ESOP transactions may constitute aggressive or questionable tax schemes to benefit high-income taxpayers.

Congress has historically encouraged the formation of ESOPs by providing favorable tax treatment under the Internal Revenue Code (IRC). Nonetheless, both the IRS and the U.S. Department of Labor (DOL) have issued complex rules governing the plans’ use, which can make compliance standards burdensome for employers.

This IRS Notice clarifies that the agency is now focusing on ensuring that high-income taxpayers pay what they owe. Although the IRS Notice lacks specifics, it does raise the following issues of concern:

  • Valuation issues with employer stock.
  • Prohibited allocations of shares to “disqualified persons.”
  • Failure to satisfy the rules by which ESOPs may borrow funds to buy company stock.
  • Schemes in which a business creates an S corporation to divert taxable income to otherwise tax-exempt ESOPs.

The IRS periodically audits ESOPs for compliance with the IRC and related regulations. In its Notice, the IRS also states that it will utilize education, outreach, and additional examinations to address compliance issues with ESOPs.

About six weeks before the IRS issued this Notice, the DOL announced an initiative to promote employee ownership of businesses. This initiative is in conjunction with the DOL’s duty to implement the ESOP provisions of the SECURE 2.0 Act. The expectation is that DOL will undergo a formal rulemaking process addressing ESOP valuation issues, which remains a concern.

HBL has experience in all areas of benefits and employment law, offering a comprehensive solution to all your business benefits and HR/employment needs. We help ensure you are in compliance with the complex requirements of ERISA and the IRS code, as well as those laws that impact you and your employees. Together, we reduce your exposure to potential legal or financial penalties. Learn more by calling 470-571-1007.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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