What’s in a number?

Numbers can be powerful recall aids.  Take 409 for example.  Most Americans think of the household cleaner Formula 409.  Invented in 1957 it was the 409th compound tested by the creators (talk about perseverance).  This family of products is now found under sinks and counters throughout the country.

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S-Corporations with an Employee Stock Ownership Plan (ESOP) are likely to think about Internal Revenue Code Section 409(p) anti-abuse testing.  The purpose of this code section is to prevent any individual, collection of individuals or family group from having too much concentration of ownership (and directly benefitting from the deferral of taxes).  The tests look at direct and indirect ownership (such as the ESOP) and any synthetic equity.  Synthetic equity includes warrants, options, nonqualified deferred compensation to name just a few.  A complete description of 409(p) would take several pages and would leave more than a few of us with our eyes glazed over.

Failing 409(p) testing has dire consequences for the company and the impacted individuals.  Does this mean that S-Corporations should not consider ESOPs?  No, there are many tax advantages for an S-Corporation that establishes an ESOP.  There are many, many successful S-Corporation ESOPs in the U.S.

But it does remind me of the proverb:

He who fails to plan, plans to fail.

Anti-abuse testing should be one of the considerations factored into the initial design of the ESOP and in any subsequent transactions or equity changes.  It is important to have this conversation early in the process to avoid any surprises following implementation.  An ESOP consultant can help you model this test and design your plan to meet the requirements of the Internal Revenue Code.

Formula 409 helps you keep your kitchen and bath clean.  An ESOP consultant can help you keep your ESOP clean in regards to Section 409(p).

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In addition to blogging here, I also tweet regularly about topics of interest to ESOPs. Click to follow me on Twitter –  @jlripperger.

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Affiliation Disclosures

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that none of the member companies of The Principal are rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services are provided by Principal Life Insurance Company a member of the Principal Financial Group® (The Principal®), Des Moines, IA 50392.

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