Until now the Service has not approved the use of an ESOP for any entity other than a traditional business corporation. However, the IRS recently ruled in PLR 201538021 that an LLC that has elected to be taxed as an association can establish an ESOP and that unit shares of membership were “employer securities” for purposes of § 409 (l) (2). With the use of LLCs that elect to be treated like corporations for tax purposes being fairly common these days, this ruling follows that trend if the LLC establishes defined shares or units of ownership interest equivalent to corporate stock.
Under Code § 4975 (e) (7) an employee stock ownership plan (ESOP) is a stock bonus plan designed to invest primarily in qualifying “employer securities.” Under § 409 (l) this terms means publicly traded common stock or, if there is no traded common stock, common stock that has the same voting power and dividend rights as the class of stock with the greatest voting power and dividend rights. Even though an LLC does not issue stock of any kind, the Service reasoned that “unit shares” created by an operating agreement in an LLC that has elected to be taxed as an association can be considered the same as stock for ESOP purposes.
ESOPs offer a unique planning opportunity for successful companies structuring ownership succession. An ESOP can, for example, allow current owners to sell a portion of their stock (or now LLC units) to the plan on favorable tax terms, and if the plan borrows to fiancé the purchase, the debt payments can be deductible profit sharing contributions. An ESOP is not right for every situation but, when one is a good fit, it provides great benefits to the current owners and to the enterprise, as well as giving an ownership stake to employees.
If you have questions about ESOPs or LLCs feel free to contact Bryan Dench, Norman Rattey, or Ted Small.
This article is not legal advice but should be considered as general guidance in the area of corporate law. You can contact us at 784-3200 (telephone). Skelton Taintor & Abbott is a full service law firm providing legal services to individuals, companies, and municipalities throughout Maine. It has been in operation since its founding in 1853.