26 USC 409 - Qualifications for tax credit employee stock ownership plans

U.S Code last checked for updates: Jan 18, 2025

§ 409.

Qualifications for tax credit employee stock ownership plans

(a)

Tax credit employee stock ownership plan defined

Except as otherwise provided in this title, for purposes of this title, the term “tax credit employee stock ownership plan” means a defined contribution plan which—

(1)

meets the requirements of section 401(a),

(2)

is designed to invest primarily in employer securities, and

(3)

meets the requirements of subsections (b), (c), (d), (e), (f), (g), (h), and (o) of this section.

(b)

Required allocation of employer securities

(1)

In general

A plan meets the requirements of this subsection if—

(A)

the plan provides for the allocation for the plan year of all employer securities transferred to it or purchased by it (because of the requirements of section 41(c)(1)(B)) 1

 See References in Text note below.

to the accounts of all participants who are entitled to share in such allocation, and

(B)

for the plan year the allocation to each participant so entitled is an amount which bears substantially the same proportion to the amount of all such securities allocated to all such participants in the plan for that year as the amount of compensation paid to such participant during that year bears to the compensation paid to all such participants during that year.

(2)

Compensation in excess of $100,000 disregarded

(3)

Determination of compensation

(4)

Suspension of allocation in certain cases

(c)

Participants must have nonforfeitable rights

(d)

Employer securities must stay in the plan

(1)

death, disability, separation from service, or termination of the plan;

(2)

a transfer of a participant to the employment of an acquiring employer from the employment of the selling corporation in the case of a sale to the acquiring corporation of substantially all of the assets used by the selling corporation in a trade or business conducted by the selling corporation, or

(3)

with respect to the stock of a selling corporation, a disposition of such selling corporation’s interest in a subsidiary when the participant continues employment with such subsidiary.

This subsection shall not apply to any distribution required under section 401(a)(9) or to any distribution or reinvestment required under section 401(a)(28).

(e)

Voting rights

(1)

In general

(2)

Requirements where employer has a registration-type class of securities

(3)

Requirement for other employers

(4)

Registration-type class of securities defined

For purposes of this subsection, the term, “registration-type class of securities” means—

(A)

a class of securities required to be registered under section 12 of the Securities Exchange Act of 1934, and

(B)

a class of securities which would be required to be so registered except for the exemption from registration provided in subsection (g)(2)(H) of such section 12.

(5)

1 vote per participant

A plan meets the requirements of paragraph (3) with respect to an issue if—

(A)

the plan permits each participant 1 vote with respect to such issue, and

(B)

the trustee votes the shares held by the plan in the proportion determined after application of subparagraph (A).

(f)

Plan must be established before employer’s due date

(1)

In general

(2)

Special rule for first year

(g)

Transferred amounts must stay in plan even though investment credit is redetermined or recaptured

(h)

Right to demand employer securities; put option

(1)

In general

A plan meets the requirements of this subsection if a participant who is entitled to a distribution from the plan—

(A)

has a right to demand that his benefits be distributed in the form of employer securities, and

(B)

if the employer securities are not readily tradable on an established market, has a right to require that the employer repurchase employer securities under a fair valuation formula.

(2)

Plan may distribute cash in certain cases

(A)

In general

(B)

Exception for certain plans restricted from distributing securities

(i)

In general

(ii)

Applicable plans

This subparagraph shall apply to a plan which otherwise meets the requirements of this subsection or section 4975(e)(7) and which is established and maintained by—

(I)

an employer whose charter or bylaws restrict the ownership of substantially all outstanding employer securities to employees or to a trust described in section 401(a), or

(II)

an S corporation.

(3)

Special rule for banks

(4)

Put option period

(5)

Payment requirement for total distribution

If an employer is required to repurchase employer securities which are distributed to the employee as part of a total distribution, the requirements of paragraph (1)(B) shall be treated as met if—

(A)

the amount to be paid for the employer securities is paid in substantially equal periodic payments (not less frequently than annually) over a period beginning not later than 30 days after the exercise of the put option described in paragraph (4) and not exceeding 5 years, and

(B)

there is adequate security provided and reasonable interest paid on the unpaid amounts referred to in subparagraph (A).

For purposes of this paragraph, the term “total distribution” means the distribution within 1 taxable year to the recipient of the balance to the credit of the recipient’s account.

(6)

Payment requirement for installment distributions

(7)

Exception where employee elected diversification

(i)

Reimbursement for expenses of establishing and administering plan

A plan which otherwise meets the requirements of this section shall not be treated as failing to meet such requirements merely because it provides that—

(1)

Expenses of establishing plan

As reimbursement for the expenses of establishing the plan, the employer may withhold from amounts due the plan for the taxable year for which the plan is established (or the plan may pay) so much of the amounts paid or incurred in connection with the establishment of the plan as does not exceed the sum of—

(A)

10 percent of the first $100,000 which the employer is required to transfer to the plan for that taxable year under section 41(c)(1)(B),¹ and

(B)

5 percent of any amount so required to be transferred in excess of the first $100,000; and

(2)

Administrative expenses

As reimbursement for the expenses of administering the plan, the employer may withhold from amounts due the plan (or the plan may pay) so much of the amounts paid or incurred during the taxable year as expenses of administering the plan as does not exceed the lesser of—

(A)

the sum of—

(i)

10 percent of the first $100,000 of the dividends paid to the plan with respect to stock of the employer during the plan year ending with or within the employer’s taxable year, and

(ii)

5 percent of the amount of such dividends in excess of $100,000 or

(B)

$100,000.

(j)

Conditional contributions to the plan

A plan which otherwise meets the requirements of this section shall not be treated as failing to satisfy such requirements (or as failing to satisfy the requirements of section 401(a) of this title or of section 403(c)(1) of the Employee Retirement Income Security Act of 1974) merely because of the return of a contribution (or a provision permitting such a return) if—

(1)

the contribution to the plan is conditioned on a determination by the Secretary that such plan meets the requirements of this section,

(2)

the application for a determination described in paragraph (1) is filed with the Secretary not later than 90 days after the date on which an employee plan credit is claimed, and

(3)

the contribution is returned within 1 year after the date on which the Secretary issues notice to the employer that such plan does not satisfy the requirements of this section.

(k)

Requirements relating to certain withdrawals

Notwithstanding any other law or rule of law—

(1)

the withdrawal from a plan which otherwise meets the requirements of this section by the employer of an amount contributed for purposes of the matching employee plan credit shall not be considered to make the benefits forfeitable, and

(2)

the plan shall not, by reason of such withdrawal, fail to be for the exclusive benefit of participants or their beneficiaries,

if the withdrawn amounts were not matched by employee contributions or were in excess of the limitations of section 415. Any withdrawal described in the preceding sentence shall not be considered to violate the provisions of section 403(c)(1) of the Employee Retirement Income Security Act of 1974. For purposes of this subsection, the reference to the matching employee plan credit shall refer to such credit as in effect before the enactment of the Tax Reform Act of 1984.

(l)

Employer securities defined

For purposes of this section—

(1)

In general

(2)

Special rule where there is no readily tradable common stock

If there is no common stock which meets the requirements of paragraph (1), the term “employer securities” means common stock issued by the employer (or by a corporation which is a member of the same controlled group) having a combination of voting power and dividend rights equal to or in excess of—

(A)

that class of common stock of the employer (or of any other such corporation) having the greatest voting power, and

(B)

that class of common stock of the employer (or of any other such corporation) having the greatest dividend rights.

(3)

Preferred stock may be issued in certain cases

(4)

Application to controlled group of corporations

(A)

In general

(B)

Where common parent owns at least 50 percent of first tier subsidiary

(C)

Where common parent owns 100 percent of first tier subsidiary

(5)

Nonvoting common stock may be acquired in certain cases

(m)

Nonrecognition of gain or loss on contribution of employer securities to tax credit employee stock ownership plan

(n)

Securities received in certain transactions

(1)

In general

A plan to which section 1042 applies and an eligible worker-owned cooperative (within the meaning of section 1042(c)) shall provide that no portion of the assets of the plan or cooperative attributable to (or allocable in lieu of) employer securities acquired by the plan or cooperative in a sale to which section 1042 applies may accrue (or be allocated directly or indirectly under any plan of the employer meeting the requirements of section 401(a))—

(A)

during the nonallocation period, for the benefit of—

(i)

any taxpayer who makes an election under section 1042(a) with respect to employer securities,

(ii)

any individual who is related to the taxpayer (within the meaning of section 267(b)), or

(B)

for the benefit of any other person who owns (after application of section 318(a)) more than 25 percent of—

(i)

any class of outstanding stock of the corporation which issued such employer securities or of any corporation which is a member of the same controlled group of corporations (within the meaning of subsection (l)(4)) as such corporation, or

(ii)

the total value of any class of outstanding stock of any such corporation.

For purposes of subparagraph (B), section 318(a) shall be applied without regard to the employee trust exception in paragraph (2)(B)(i).

(2)

Failure to meet requirements

If a plan fails to meet the requirements of paragraph (1)—

(A)

the plan shall be treated as having distributed to the person described in paragraph (1) the amount allocated to the account of such person in violation of paragraph (1) at the time of such allocation,

(B)

the provisions of section 4979A shall apply, and

(C)

the statutory period for the assessment of any tax imposed by section 4979A shall not expire before the date which is 3 years from the later of—

(i)

the 1st allocation of employer securities in connection with a sale to the plan to which section 1042 applies, or

(ii)

the date on which the Secretary is notified of such failure.

(3)

Definitions and special rules

For purposes of this subsection—

(A)

Lineal descendants

Paragraph (1)(A)(ii) shall not apply to any individual if—

(i)

such individual is a lineal descendant of the taxpayer, and

(ii)

the aggregate amount allocated to the benefit of all such lineal descendants during the nonallocation period does not exceed more than 5 percent of the employer securities (or amounts allocated in lieu thereof) held by the plan which are attributable to a sale to the plan by any person related to such descendants (within the meaning of section 267(c)(4)) in a transaction to which section 1042 applied.

(B)

25-percent shareholders

A person shall be treated as failing to meet the stock ownership limitation under paragraph (1)(B) if such person fails such limitation—

(i)

at any time during the 1-year period ending on the date of sale of qualified securities to the plan or cooperative, or

(ii)

on the date as of which qualified securities are allocated to participants in the plan or cooperative.

(C)

Nonallocation period

The term “nonallocation period” means the period beginning on the date of the sale of the qualified securities and ending on the later of—

(i)

the date which is 10 years after the date of sale, or

(ii)

the date of the plan allocation attributable to the final payment of acquisition indebtedness incurred in connection with such sale.

(o)

Distribution and payment requirements

A plan meets the requirements of this subsection if—

(1)

Distribution requirement

(A)

In general

The plan provides that, if the participant and, if applicable pursuant to sections 401(a)(11) and 417, with the consent of the participant’s spouse elects, the distribution of the participant’s account balance in the plan will commence not later than 1 year after the close of the plan year—

(i)

in which the participant separates from service by reason of the attainment of normal retirement age under the plan, disability, or death, or

(ii)

which is the 5th plan year following the plan year in which the participant otherwise separates from service, except that this clause shall not apply if the participant is reemployed by the employer before distribution is required to begin under this clause.

(B)

Exception for certain financed securities

(C)

Limited distribution period

The plan provides that, unless the participant elects otherwise, the distribution of the participant’s account balance will be in substantially equal periodic payments (not less frequently than annually) over a period not longer than the greater of—

(i)

5 years, or

(ii)

in the case of a participant with an account balance in excess of $800,000, 5 years plus 1 additional year (but not more than 5 additional years) for each $160,000 or fraction thereof by which such balance exceeds $800,000.

(2)

Cost-of-living adjustment

(p)

Prohibited allocations of securities in an S corporation

(1)

In general

(2)

Failure to meet requirements

(A)

In general

(B)

Cross reference

(3)

Nonallocation year

For purposes of this subsection—

(A)

In general

The term “nonallocation year” means any plan year of an employee stock ownership plan if, at any time during such plan year—

(i)

such plan holds employer securities consisting of stock in an S corporation, and

(ii)

disqualified persons own at least 50 percent of the number of shares of stock in the S corporation.

(B)

Attribution rules

For purposes of subparagraph (A)—

(i)

In general

The rules of section 318(a) shall apply for purposes of determining ownership, except that—

(I)

in applying paragraph (1) thereof, the members of an individual’s family shall include members of the family described in paragraph (4)(D), and

(II)

paragraph (4) thereof shall not apply.

(ii)

Deemed-owned shares

Solely for purposes of applying paragraph (5), this subparagraph shall be applied after the attribution rules of paragraph (5) have been applied.

(4)

Disqualified person

For purposes of this subsection—

(A)

In general

The term “disqualified person” means any person if—

(i)

the aggregate number of deemed-owned shares of such person and the members of such person’s family is at least 20 percent of the number of deemed-owned shares of stock in the S corporation, or

(ii)

in the case of a person not described in clause (i), the number of deemed-owned shares of such person is at least 10 percent of the number of deemed-owned shares of stock in such corporation.

(B)

Treatment of family members

(C)

Deemed-owned shares

(i)

In general

The term “deemed-owned shares” means, with respect to any person—

(I)

the stock in the S corporation constituting employer securities of an employee stock ownership plan which is allocated to such person under the plan, and

(II)

such person’s share of the stock in such corporation which is held by such plan but which is not allocated under the plan to participants.

(ii)

Person’s share of unallocated stock

(D)

Member of family

For purposes of this paragraph, the term “member of the family” means, with respect to any individual—

(i)

the spouse of the individual,

(ii)

an ancestor or lineal descendant of the individual or the individual’s spouse,

(iii)

a brother or sister of the individual or the individual’s spouse and any lineal descendant of the brother or sister, and

(iv)

the spouse of any individual described in clause (ii) or (iii).

A spouse of an individual who is legally separated from such individual under a decree of divorce or separate maintenance shall not be treated as such individual’s spouse for purposes of this subparagraph.

(5)

Treatment of synthetic equity

For purposes of paragraphs (3) and (4), in the case of a person who owns synthetic equity in the S corporation, except to the extent provided in regulations, the shares of stock in such corporation on which such synthetic equity is based shall be treated as outstanding stock in such corporation and deemed-owned shares of such person if such treatment of synthetic equity of 1 or more such persons results in—

(A)

the treatment of any person as a disqualified person, or

(B)

the treatment of any year as a nonallocation year.

For purposes of this paragraph, synthetic equity shall be treated as owned by a person in the same manner as stock is treated as owned by a person under the rules of paragraphs (2) and (3) of section 318(a). If, without regard to this paragraph, a person is treated as a disqualified person or a year is treated as a nonallocation year, this paragraph shall not be construed to result in the person or year not being so treated.

(6)

Definitions

For purposes of this subsection—

(A)

Employee stock ownership plan

(B)

Employer securities

(C)

Synthetic equity

(7)

Regulations and guidance

(A)

In general

(B)

Avoidance or evasion

(Added Pub. L. 95–600, title I, § 141(a), Nov. 6, 1978, 92 Stat. 2787, § 409A; amended Pub. L. 96–222, title I, § 101(a)(7)(D)–(F), (I), (J), (L)(i)(VI), (ii)(I), (II), (iii)(V), (v)(VI), (VII), Apr. 1, 1980, 94 Stat. 198–200; Pub. L. 96–605, title II, § 224(a), Dec. 28, 1980, 94 Stat. 3528; Pub. L. 97–34, title III, §§ 331(c)(1), 334, 336, 337(a), Aug. 13, 1981, 95 Stat. 293, 297, 298; Pub. L. 97–448, title I, § 103(h), (i), Jan. 12, 1983, 96 Stat. 2379; renumbered § 409 and amended Pub. L. 98–369, div. A, title IV, §§ 474(r)(15), 491(e)(1), July 18, 1984, 98 Stat. 843, 852; Pub. L. 99–514, title XI, §§ 1172(b)(1), 1174(a)(1), (b)(1), (2), (c)(1)(A), 1176(b), title XVIII, §§ 1852(a)(4)(B), 1854(a)(3)(A), (f)(1), (3)(C), 1899A(11), Oct. 22, 1986, 100 Stat. 2514, 2516, 2517, 2520, 2865, 2873, 2881, 2882, 2958; Pub. L. 100–647, title I, §§ 1011B(g)(1), (2), (i)(1), (3), (j)(3), (5), (k)(3), 1018(t)(4)(B), (C), (H), Nov. 10, 1988, 102 Stat. 3490, 3492, 3493, 3588, 3589; Pub. L. 101–239, title VII, §§ 7304(a)(2)(A), (B), 7811(h)(1), Dec. 19, 1989, 103 Stat. 2352, 2353, 2409; Pub. L. 105–34, title XV, § 1506(a), Aug. 5, 1997, 111 Stat. 1064; Pub. L. 107–16, title VI, § 656(a), June 7, 2001, 115 Stat. 131; Pub. L. 107–147, title IV, § 411(j)(2), Mar. 9, 2002, 116 Stat. 47; Pub. L. 109–280, title IX, § 901(a)(2)(B), Aug. 17, 2006, 120 Stat. 1029; Pub. L. 113–295, div. A, title II, § 221(a)(54), Dec. 19, 2014, 128 Stat. 4045; Pub. L. 115–141, div. U, title IV, § 401(a)(79), Mar. 23, 2018, 132 Stat. 1187.)

cite as: 26 USC 409