While we might think of the Internal Revenue Service (IRS) as just waiting to catch us in some error on our taxes, the IRS spends a lot of energy informing taxpayers and relevant stakeholders of the agency's priorities so they will fix issues before they ever rise to the level of an enforcement issue. There's a case in point with an August 2023 news release. In that statement, the IRS has said that, as part of a newly increased focus on high-income taxpayers, it wants employers to be aware of compliance issues relating to employee stock ownership plans (ESOPs).

When Someone Is Hiding Assets to Avoid Taxes

ESOPs are retirement plans that give employees stock in the company. While any company that issues stock can create an ESOP, the IRS says that some companies have been using ESOPs to skirt taxation laws regarding compensation.

According to the release, the IRS has identified several compliance issues relating to ESOPs. For example, companies are failing to set the stock valuation of the employees' stock correctly. Still others are allocating shares to people not qualified to participate in the ESOP.

Another focus of IRS concern is related to ESOP loans.

First, ESOPs can borrow money from either the parent company or a third party. However, the IRS finds that some firms fail to follow tax law for these loans, so the loans become a prohibited transaction.

At the same time, the IRS has identified instances when a company creates an S-corporation to use as a management company wholly owned by the ESOP. However, the IRS believes that business owners are creating these S-corporations to divert income from the business, which it then “loans” back to the business's owners. The IRS believes these loans are taxable income, and it is considering whether other laws will lead to stripping these management companies of their S-corporation status.

Employers with ESOPs should consider this notice as just an opening salvo. The IRS has announced that it will continue examining ESOP practices and release further compliance guidance in the coming months.

If you're a business owner who has an ESOP program or an employee who has stock in your retirement plan, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.