On August 9, the IRS issued a news release, IR-2023-144, warning taxpayers and advisors of “numerous compliance issues” with ESOPs, such as “valuation issues with employee stock,” “prohibited allocation of shares to disqualified persons,” “failure to follow tax law requirements for ESOP loans causing the loan to be a prohibited transaction” and “promoted arrangements using ESOPs that are potentially abusive.” Naturally, this out-of-nowhere release caused quite a bit of bad blood in the ESOP community because the tone of the release made it sound like ESOPs were in trouble. We fielded questions from several ESOP clients asking what this was about and if they should be concerned about an IRS agent arriving to audit their plans – which, if timed right, could lead to a cruel summer.

Since then, the IRS has provided more insight into what triggered the news release, and as expected, most ESOP sponsors should be able to shake it off. We’ve learned that the IRS issued the release to alert interested parties and the employee ownership community that they’ve identified what they’ve termed a “questionable transaction” sold by a small number of promoters. These generally involve small medical or dental practices in which an ESOP is set up through a management company that provides services to the practice (which, in most states, can’t have an ESOP due to ownership restrictions). The management company then charges fees to the practice for management services, but at a level that takes most or all of the profit out of the practice, resulting in the group’s income flowing into a 100% ESOP S corporation, which is exempt from income taxes. Then, the management company loans its retained earnings to the practice’s owners, giving those owners cash flow without taxes. How or when those loans ever get paid back is somewhat of a mystery. 

The good news is that the IRS has made an effort to let the ESOP world know that its concerns only involve a few promoters, and the broader community still has a good reputation. Most plan sponsors who set up ESOPs for the right reason have no need for concern about enhanced IRS enforcement activities. The release is only about those promoters who twist the law to a point where the transactions toe the line of abusiveness, which happens with nearly every other part of the tax code. It sounds like karma will ultimately catch up to those promoters.

The Jackson Lewis Employee Benefits Practice Group members can assist if you have questions or need assistance. Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work.

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Photo of M. John Burgess M. John Burgess

A certified public accountant and attorney with an extensive tax and accounting background including experience as an auditor with a large accounting firm, John brings a practical approach to the legal counsel he provides to employee benefit plan committees, including 401(k) plan committees…

A certified public accountant and attorney with an extensive tax and accounting background including experience as an auditor with a large accounting firm, John brings a practical approach to the legal counsel he provides to employee benefit plan committees, including 401(k) plan committees, regarding their fiduciary responsibilities. Clients appreciate his ability to provide a comprehensive view of their specific benefit plans and how they affect their business. Business owners and executives leverage John’s nearly 20 years of experience in employee benefits, executive compensation matters, and employee stock ownership plans (ESOPs). John regularly represents clients before the Internal Revenue Service (IRS) and department of Labor (DOL) in benefits matters.

A significant portion of John’s practice is centered on establishing and maintaining ESOPs for a nationwide client base, including plan design, distribution policies, the structure and implementation of ESOP transactions and administration matters. John also regularly represents ESOP trustees in purchase and sale transactions. In 2020, he helped to establish the Florida Center for Employee Ownership, a statewide resource for business owners who are considering a transition of the ownership of a business to its employees and is a member of its Board of Directors. He speaks regularly on ESOP issues at national and regional conferences.

John plays a critical role in navigating the complex and potentially risky issues that can arise during an M&A transaction. Clients draw on his benefits issues experience, including assistance with the due diligence on benefit plans sponsored by an acquired company. He routinely counsels clients on plan documentation, plan qualification, and other benefits issues, including tax and fiduciary matters.

Having worked with plans of all sizes, ranging from those sponsored by small, local companies to large, multi-national corporations, John has guided business owners, executives, and other senior managers with a range of employee benefits. Employers at all stages, from startups to public companies, seek John for advice and counsel on how to establish and maintain equity-based compensation programs for executives and employees.

Clients value John’s significant experience assisting in the correction of errors in both qualified and non-qualified retirement plans. This includes representing clients in Voluntary Compliance Program applications before the IRS, providing the opportunity to maintain compliance with IRS regulations and the potential for saving significant penalties and fees. He regularly assists clients with executive employment agreements, severance agreements, change in control agreements and non-qualified deferred compensation plans, including compliance with Internal Revenue Code Sections 409A, 457(b) and 457(f).