Abusive Tax Avoidance Transactions (ATATs): ESOPs Adopted by an LLC and Rollovers as Business Startups (ROBS)
Last week the IRS conducted a phone forum on Abusive Tax Avoidance Transactions (ATATs) and Emerging Issues. The handout referenced an ESOP adopted by an LLC:
ESOP adopted by an LLC
We received a lead from a Determination Specialist about a potential issue involving an ESOP adopted by an LLC. We have only identified two cases for the practitioner who submitted the Determination request. We selected one of the cases for EP examination in order to learn more about the transaction.
The IRS previously discussed ESOPs and LLCs and Including the Holding Period of a Predecessor Company for a Section 1042 Sale in a 2008 private letter ruling (PLR).
The forum also discussed a number of ATATs, including Rollovers as Business Startups (ROBS):
ROBS - Rollover as Business Start-ups
ROBS arrangements were created to secure available funds held in tax-deferred savings (usually under a prior employer's plan) for an aspiring entrepreneur without incurring resultant tax liabilities that would ordinarily apply to a distribution.
While the form of ROBS transactions is not prohibited per se the IRS is concerned with these transactions for several reasons:
- The ROBS transaction is accomplished without any imposition of the taxes that ordinarily attach to distributions from retirement plan savings accounts
- Distributions would normally be subject to treatment as ordinary income, taxable at the individual's personal tax rates, with possible additions to tax in the form of early distribution penalties
- ROBS transactions effectively avoid all these tax concerns
When analyzing ROBS transactions on plans that were examined, the Service found several technical violations of the law applicable to employee benefit plans. For example:
- The exchange of stock results in all shares contributed to the plan being allocated to the account of the entrepreneur only
- No other current or future employees will ever receive their required right to invest in employer stock, in possible violation of nondiscrimination requirements
- Stock is exchanged without any real attempt to determine its value. The stock is said to be equal in value to whatever happens to be available to exchange for it which creates a prohibited transaction
IRS EP aggressively monitoring abusive tax-avoidance transactions, officials say also provides a recap of the conference, stressing the importance of having an independent valuation of the stock:
Templeman and Patton discussed a number of ATATs that are currently under EP scrutiny, including ROBS and others. ROBS are not an abuse, per se; they are arrangements that can lend themselves to problems. The IRS is concerned about ROBS transactions because they are accomplished without any imposition of taxes that ordinarily attach to distributions from retirement plan savings accounts, Templeman said. ROBS arrangements were created to secure available funds held in tax-deferred savings, typically an employer's plan, for an aspiring entrepreneur without incurring tax liabilities that would ordinarily apply to a distribution, Templeman explained.
The IRS is concerned about these transactions because distributions would normally be subject to treatment as ordinary income, with possible additions to tax in the form of early distribution penalties. Moreover, the transaction is one that has a lot of compliance issues the IRS has seen when doing exams, said Templeman. Of "significant" concern, she continued, is that stock is exchanged in a ROBS transaction and no independent effort is made to determine the value of the stock.