Tax Court Agrees with IRS that ESOP with Operational/Form Errors is Non-Qualified

The U.S. Tax Court has found that an Iowa corporation’s employee stock ownership plan (ESOP) and employee stock ownership trust (ESOT) do not qualify as retirement plans under federal tax law due to operational and form deficiencies.

The case — Ed Thielking Inc. v. Commissioner of Internal Revenue — involved an S corporation incorporated on March 10, 2006, with Ed Thielking as sole shareholder.  Ed also served as an officer and director in the S corporation, as did his wife, Amy Thielking.  The S corporation’s primary asset was a 50 percent interest in a partnership called Gray Thielking Electric (GTE), which Ed transferred to the taxpayer.

The taxpayer established an ESOP and an ESOT on March 31, 2006, with Amy listed as trustee of the ESOT.  The ESOP plan required that:

  • Employee participation in the ESOP begins after one year of service
  • Employee contributions to the ESOP can only be made after the employee completes 1,000 hours of service during a plan year

For the tax year at issue in this case, the taxpayer did not report any officer compensation and did not file any employment tax returns.

During the first year of the plan, the taxpayer issued a dividend of capital stock to plan participants.  Ed directed the taxpayer to deposit his dividend — 23,000 shares of corporation stock — into his ESOT account.  The value of those shares was calculated at $1 per share by Ed’s father, Stephen Thielking, who is a CPA and set up the taxpayer’s ESOP and ESOT plans.

On its tax return for its first year, the taxpayer reported that Ed was the sole ESOP participant, with 23,000 shares of stock in his account.

After conducting an audit of the ESOP, the IRS concluded that it was not a qualified plan due to a number of operational and form deficiencies, including the following:

  • There was no evidence that Ed had one year of service with the taxpayer or that he worked for at least 1,000 hours, which disqualified him as a plan participant.
  • Because the taxpayer failed to file any employment tax returns (including Form W-2), there was no evidence that Ed was compensated for any services performed for the taxpayer.
  • The share value appraisal performed by Stephen Thielking was not a qualified appraisal because it was not conducted by a qualified independent appraiser, was not signed, and did not include the appraiser’s credentials as required by law.
  • The ESOP itself had form failures, as the taxpayer failed to amend the plan documents to keep up with changes in the law.

We help organizations establish benefits plans that are right for their members, put processes in place to ensure regulatory compliance, and keep those benefit plans updated based on changes in laws and regulations. To learn more about the employee benefits legal compliance services we offer at Hall Benefits Law, call 678-439-6236 today.

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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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