ESOP Lawyer & Attorney : Sheppard Mullin Law Firm : Employee Stock Ownership Plans : ESOP Law Blog

In January 2008, the IRS published proposed regulations ("Proposed Regulations") under the new ESOP diversification rules of Section 401(a)(35) of the Internal Revenue Code ("Code").  The Proposed Regulations could impact several ESOP provisions of the Code, including: the independent appraiser requirement of Section 401(a)(28)(C), the put option rules of Section 409(h)(1)(B), the definition of employer securities under Section 409(l)(1), and the eligibility for a tax deferred sale to an ESOP under Section 1042, all of which apply to employer stock that is not publicly-traded.

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H.R. 3970 introduced by Hon. Charles Rangel on October 25, 2007, includes a Section 3701 that would add Section 409B to the Internal Revenue Code. The new provision would create an additional income tax on the holder of synthetic equity (as defined in Section 409(p)). The new rule would provide that when the holder "exercises" the synthetic equity, in addition to any taxable gain he may recognize from the exercise of the instrument, he must also recognize a new taxable amount. That amount is calculated by determining the amount of S corporation income the holder would have recognized each year, had he held actual stock instead of synthetic equity. In addition, once that amount of additional tax liability is calculated, Section 409B imposes an interest charge on the amount at the underpayment interest rates.

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In December, the IRS published in final form the long-awaited regulations (“Final Regs”) under Internal Revenue Code (“IRC”) Section 409(p). These regulations were first published in proposed form in 2003, and then again as proposed and temporary regulations in 2004. The Final Regs largely follow the 2004 temporary regulations. We thought it would be helpful to discuss the issues the IRS considered in finalizing the regulations and the conclusions reached. In a future ESOP Blog, we will explore some of the difficult and unresolved 409(p) issues that remain in the Final Regs

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