Can an LLC Adopt an ESOP? IRS Says Yes
In a private letter ruling released on September 18, 2015 (PLR 201538021), the Internal Revenue Service concluded that an employer organized as a limited liability company (LLC) under a state statute, upon making a federal tax election to be taxed as a corporation, can adopt an employee stock ownership plan under Internal Revenue Code Section 4975(e)(7) (“ESOP”).
Section 4975(e)(7) defines an ESOP as a defined contribution retirement plan designed to invest primarily in “qualified employer securities”. Code Section 409(l) defines “employer securities” as “common stock issued by the employer (or by a corporation which is a member of the same controlled group).” In the ruling, the IRS examined various other terms under Code Section 7701, including the terms “corporation” and “stock.” Concluding that the term “corporation” includes associations and that the term “stock” includes shares in an association, the IRS determined that in the case presented, once the company elected to be classified as association taxable as a corporation, the units in the LLC would be treated as shares of stock for purposes of the tax code. Assuming that the other requirements under Code Section 409(l) are satisfied (shares must have the highest voting and liquidation rights or be convertible into shares with the highest voting and liquidation rights), the units would be considered qualified employer securities for the purpose of the ESOP rules.
Previously ESOP practitioners believed that in order for owners of an LLC to consider an ESOP as an ownership succession strategy, the LLC would need to reorganize under state and federal law as a corporation through a liquidation and recapitalization. This process is more costly and raised other legal issues.
It should be noted that a private letter ruling can only be relied upon by the party to which it was issued and has no force of law in the federal courts. However, such rulings are instructive as to current positions being taken by the Internal Revenue Service when examining transactions with facts similar to those described in the ruling.
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