Corporation not entitled to 404(k) deduction for redemption of stock used to satisfy ESOP distribution obligations discusses General Mills, Inc. v. United States, No. 08-1638 (8th Cir., January 26, 2009), which found that a corporation was not entitled to an IRC Section 404(k) deduction for the proceeds from a stock redemption that were used to fund cash distributions:

The corporation maintained three employee retirement plans which included employee stock ownership plan (ESOP) components. Upon the termination of an employee, the ESOP trust was required to distribute the value of the employee's vested ESOP account. The employee could elect to receive either shares of the corporation's common stock or their cash equivalent. The trust could satisfy its cash distribution obligations by using the proceeds of redemptions of shares of common stock, or in several other ways. The corporation chose to redeem shares of its common stock held by the trust ("redemptive dividends"), and the trust then used some of the proceeds from the redemptive dividends to satisfy portions of its cash distribution obligations ("cash distribution redemptive dividends").

The corporation sought to deduct the cash distribution redemptive dividends under Code Sec. 404(k)(1), which allows a deduction for the amount of any "applicable dividend" paid in cash by the corporation during the taxable year "with respect to applicable employer securities."

The district court ruled for the corporation and the appellate court reversed, declining to follow the holding in Boise Cascade Corp. v. U.S. (9th Cir., No. 01-36086, 5/20/03.

We discussed the details of the ESOP-related issues of the original General Mills ruling and the Boise Cascaade ruling in Deductible Redemptive Dividends Used to Fund ESOP Distributions:

Original General Mills Ruling

• General Mills v. United States, No. 06-3547 (DSD/SRN, Jan. 14, 2008)
• General Mills redeemed stock to fund a portion of their cash distributions. They treated the redemptions as deductible dividends under IRC Section 404(k) - Deduction for dividends paid on certain employer securities.
• The IRS denied the deduction and sued based on IRS Revenue Ruling 2001-6 - Section 404.--Deduction For Contributions Of An Employer To An Employees' Trust Or Annuity Plan And Compensation Under A Deferred-Payment Plan and IRC Section 162(k) – Stock reacquisition expenses. The IRS lost the ruling.

Boise Cascade Ruling

• Boise Cascade Corp. v. U.S. (9th Cir., No. 01-36086, 5/20/03)
  
• The company redeemed stock of participants upon termination and either distributed the cash to participants or allowed it to be invested in another investment account. If the participant received a cash distribution, the company considered the redemption a deductible dividend under IRC Section 404(k) - Deduction for dividends paid on certain employer securities.
  
• The company amended a prior return to take the deduction. The IRS disallowed it. The district court and the appeals court ruled for the company.
  
• As a result of this case, the IRS published IRS Revenue Ruling 2001-6 - Section 404.--Deduction For Contributions Of An Employer To An Employees' Trust Or Annuity Plan And Compensation Under A Deferred-Payment Plan.
  
• While the participants were able to roll over the distributions, they would not have been able to do so had the case been resolved at the time the distribution was processed. As a result, the company could have structured their distribution policy as follows to meet the deductibility needs of the company and the rollover needs of the participant:
  
• If the participant elected a cash distribution, the cash would be treated as a deductible dividend, would not be eligible for rollover treatment, and would not be subject to IRC Section 72(t) - 10-percent additional tax on early distributions from qualified retirement plans.
  
• If the participant elected a stock distribution, the stock would not be treated as a deductible dividend and the distribution would be eligible for rollover treatment.