New IRS Ruling Regarding Taxation of ESOP Distributions

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The national office of the Internal Revenue Service (IRS) has issued a new Technical Advice Memorandum (TAM) regarding distributions from an Employee Stock Ownership Plan (ESOP) to terminated plan participants. TAM 200841042. This TAM is important for all ESOP companies that allow or require terminated participants who receive distributions of company stock to sell that stock back to the company. The issue presented in the TAM related to a recent case involving the proper tax treatment of distributions of employer stock to a group of terminated employees who elected to sell the shares allocated to their accounts back to the company immediately upon distribution of their benefits. The local office of the IRS took the position that the terminated participants were in effect receiving their benefits in the form of cash, and that therefore the plan sponsor was liable for penalties for failing to withhold taxes in connection with the distributions. The local IRS office also took the position that the participants were not entitled to claim capital gain treatment with respect to the net unrealized appreciation on the shares that were credited to their accounts.

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