rp-03-23.pdf

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Part III

Administrative, Procedural, and Miscellaneous

26 CFR 1.1362-2: Termination of election.
(Also §§ 401, 402, 409, 1361, 1362, 1366.)

Rev. Proc. 2003-23

SECTION 1. PURPOSE

Treasury and the Service have determined that it is consistent with the purposes
of, and policies underlying, employee stock ownership plans (ESOPs) to enable an
ESOP to direct certain rollovers of distributions of S corporation stock to an individual
retirement plan (IRA) in accordance with a distributee’s election without terminating the
corporation’s S election. Accordingly, if the requirements of this revenue procedure are
satisfied, the Service will not treat a corporation’s S election as terminated when an
ESOP distributes stock of that corporation to a participant’s IRA in a direct rollover.

SECTION 2. BACKGROUND

In 1996, Congress amended § 1361(b)(1)(B) of the Internal Revenue Code to
make ESOPs (as defined in § 4975(e)(7)), along with other plans qualified under
§ 401(a), eligible S corporation shareholders. A fundamental purpose of an ESOP,
including an ESOP that holds stock in an S corporation, is to provide participants with
equity ownership in the employer corporation through participation in the ESOP,
including through distributions of employer securities to participants. See
S. Rep. 94-
938 at 180, 1976-3 C.B. 218 (stating that an ESOP “is a technique of corporate finance
designed to build beneficial equity ownership of shares in the employer corporation in its
employees“).

Section 409(h) generally requires that an ESOP provide for distributions in the
form of employer securities. An ESOP meets the requirements of § 409(h)(1)(A) if a
participant who is entitled to a distribution has the right to demand that his benefits be
distributed in the form of employer securities. Section 409(h)(2)(B) provides that an
ESOP maintained by an S corporation is permitted to provide for distributions only in
cash or for distributions of employer securities subject to a repurchase requirement
which meets the requirements of § 409(h)(1)(B).

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Under § 401(a)(31) and A-1 of § 1.401(a)(31)-1 of the Income Tax Regulations, a
qualified plan, including an ESOP, is required to permit the distributee of any eligible
rollover distribution (as defined in § 402(c)(4)) to have the distribution paid in a direct
rollover (as defined in A-3 of § 1.401(a)(31)-1) to an eligible retirement plan (as defined
in § 402(c)(8)(B)) specified by the distributee. Therefore, an ESOP that holds S
corporation stock and permits distributions in the form of employer securities is required
to permit participants to elect to have any distribution of S corporation stock that is an
eligible rollover distribution be paid in a direct rollover to an eligible retirement plan
specified by the distributee, including an IRA. An IRA trustee or custodian, however, is
not a permissible S corporation shareholder. See
§§ 1361(b) and 1361(c)(6).

Under § 409(h)(2)(B), an ESOP that provides for distributions in the form of
securities of an employer that is an S corporation is permitted to provide that the S
corporation stock included in the distribution is subject to a repurchase requirement.
Thus, an ESOP is permitted to provide that any stock in an S corporation that is
distributed is subject to immediate repurchase by the S corporation on a direct rollover
of the stock from the ESOP to an IRA.

SECTION 3. SCOPE

This revenue procedure sets forth certain requirements related to an ESOP’s
distribution of S corporation stock to a participant where the participant elects to have
the S corporation stock distributed to an IRA in a direct rollover. If these requirements
are satisfied, the Service will accept the position that the distribution does not affect the
S corporation’s election to be taxed as an S corporation.

SECTION 4. APPLICATION

The Service will accept the position that an S corporation’s election is not
affected as a result of an ESOP’s distribution of S corporation stock where the
participant directs that such stock be distributed to an IRA in a direct rollover, provided
that:

.01 The terms of the ESOP require that the S corporation repurchase its stock
immediately upon the ESOP’s distribution of the stock to an IRA;

.02 The S corporation actually repurchases the S corporation stock
contemporaneously with, and effective on the same day as, the distribution; and

.03 No income (including tax-exempt income), loss, deduction, or credit
attributable to the distributed S corporation stock under § 1366 is allocated to the
participant’s IRA.

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SECTION 5. DRAFTING INFORMATION

The principal authors of this revenue procedure are Craig Gerson of the Office of
Associate Chief Counsel (Passthroughs and Special Industries), John Ricotta of the
Office of Division Counsel/Associate Chief Counsel (Tax Exempt and Government
Entities) and Steven Linder of the Employee Plans, Tax Exempt and Government
Entities Division. For further information regarding the S corporation aspects of the
revenue procedure contact Mr. Gerson at (202) 622-3050 (not a toll-free call). For
further information regarding the employee plans aspects of the revenue procedure
contact the Employee Plans’ taxpayer assistance telephone service at 1-877-829-5500
(a toll-free call) between the hours of 8:00 a.m. and 6:30 p.m. Eastern Time, Monday
through Friday or contact Mr. Linder at (202) 283-9888 (not a toll-free call).