Deductible Redemptive Dividends Used to Fund ESOP Distributions discusses how the courts allowed a company to use redemptive dividends to make distribution payments in Boise Cascade Corp. v. U.S. (9th Cir., No. 01-36086, 5/20/03) and General Mills v. United States, No. 06-3547 (D. Minn. 1/14/08).
Yesterday, the Tax Court held in Ralston Purina Co. v. Commissioner, 131 T.C. No. 4 (September 10, 2008) that IRC Section 162(k) – Stock reacquisition expenses renders payments to an ESOP that were distributed to terminated participants nondeductible under IRC Section 404(k) because they are in connection with a redemption of stock:
P, a Missouri corporation, claimed a deduction under I.R.C. sec. 404(k) for payments made to its employee stock ownership plan in redemption of P's preferred stock owned by the plan, where the proceeds of that payment were distributed to employees terminating their participation in the plan. R argues that payments to redeem stock are not deductible under either I.R.C. sec. 404(k)(1) or (5), or in the alternative that deduction of these payments is barred by the provisions of I.R.C. sec. 162(k).
Held: I.R.C. sec. 162(k) renders the payments nondeductible because the payments are in connection with a redemption of stock. The result to the contrary reached by the U.S. Court of Appeals for the Ninth Circuit on almost identical facts in Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003), respectfully will not be followed.
Tax Court Denies Deduction for Payments Made to Redeem Preferred Stock Held by ESOP; Declines to Follow Ninth Circuit provides a summary of the case:
The taxpayer claimed a deduction under section 404(k) for payments made to redeem preferred stock held by its employee savings plan (the proceeds were then distributed to retiring or terminating employees). The IRS countered that these payments were essentially equivalent to redemption dividends (under section 302(b)(1)) and therefore were not deductible.
Before the Tax Court, the taxpayer asserted that a deduction for the payments to redeem the preferred stock was allowable and in support of its argument, relied on a decision of the Ninth Circuit in a case based on almost identical facts—Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003) (ESOP preferred stock redemption payments were allowed as deductions because the distribution payments made to withdrawing ESOP participants were not made "in connection with" redemption of stock; accordingly, section 162(k) did not apply).
The Tax Court disagreed and because an appeal from this case would lie with the Eighth Circuit, declined to follow the decision of the Ninth Circuit. Here, the Tax Court found that section 162(k) precludes a deduction of the redemption payments, and specifically rejected the Ninth Circuit's interpretation of the phrase "in connection with."
Tax Court Refuses to Follow 9th Circuit, Says § 162(k) Precludes Deduction for Payment Made to ESOP for Stock Redemption notes that Conopco, Inc. v. United States, No. 2:2004cv06025 (D.C. N.J. 12/8/04) is another case that allowed redemptive dividends to make distribution payments and that General Mills v. United States and Conopco, Inc. v. United States are both on appeal.
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