Birth of the “LLC”SOP?
Last September, the IRS surprised many ESOP practitioners when it ruled in favor of a limited liability company’s (LLC) request for approval of a critical ESOP design feature. In Private Letter Ruling 201538021, the IRS concluded that the ownership shares of the LLC could constitute employer securities for ESOP purposes, but interested LLC plan sponsors must pay careful attention to the specific facts the IRS cited in its ruling.
An LLC is generally a form of business that does not go through the formal process of incorporating, yet retains the limited liability advantages of the corporate form. Typically, LLCs are treated as partnerships by default for federal tax purposes. However, partnerships can elect to be treated as corporations for federal tax purposes, creating space for an argument that the ESOP stock requirements can be satisfied by a company not incorporated under state law that nonetheless elects corporate tax treatment.
In the ruling, the IRS summarized the history of the company at issue, including the election to change from tax treatment as a partnership to tax treatment as a corporation. The IRS also noted that the company’s operating agreement referred to ownership interests as “unit shares,” and all profits and losses of the company were allocated among shareholders in proportion to the number of unit shares held by each shareholder. Furthermore, dividend distributions were based on unit shares held, and (after amendment by the company) all shares would confer the same voting and other rights. Based on these facts, the IRS found that the unit shares were employer securities for ESOP purposes, and the LLC could thus sponsor an ESOP.
Conventional practice for an LLC interested in sponsoring an ESOP has been conversion of the LLC into a corporation for state law purposes, which carries other legal and tax consequences. Although a private letter ruling can only be relied upon by the taxpayer requesting the ruling from the IRS, this ruling outlines a roadmap for an LLC taxed as a corporation to take the position that it is eligible to sponsor an ESOP without a cumbersome conversion. However, any company considering taking such a position must carefully examine its own corporate structure in light of the facts presented in the ruling.
About the Author
Andrew leverages a unique combination of legal and tax accounting skills to provide clients with actionable business-oriented solutions to legal questions. Andrew counsels clients on a wide variety of employee benefits issues, including employee stock ownership plans (ESOPs), health and welfare plans, qualified retirement plans, and nonqualified deferred compensation plans. Andrew's tax experience covers business income tax, sales and use tax, and employment tax compliance.
Contact Andrew by email or phone (608) 252-9200.
Share this Post
Share this post with your network on Facebook, Twitter, LinkedIn and more.