Posts Tagged ‘ESOP’

Tax Roundup, 1/20/16: Divorce transfer foot fault wrecks Iowa ESOP. And: efficiency!

Wednesday, January 20th, 2016 by Joe Kristan

tax fairyMarriage explodes, ESOP explodes. S corporations and ESOPs are a tempting mix. To the extent an ESOP holds the shares of an S corporation, it becomes a tax-exempt for-profit business. This is almost like finding a real-life tax fairy. If any other tax-exempt entity holds S corporation stock, it will pay Unrelated Business Income Tax — a form of the regular corporate income tax — on its S corporation earnings.

These features draw tax-fairy seekers to the S corporation ESOP. For a Muscatine, Iowa chiropractor, the quest ended in both tax and romantic failure. The failure reminds us that ESOPs are not to be adopted lightly. It also shows that ESOP failures, unlike some marriages, last forever.

The chiropractor involved incorporated his practice in 1999, made an S corporation election, and immediately established an ESOP. He and his wife were the only shareholders and only ESOP participants.

The marriage broke up in 2007. In 2009, the ex-wife left the company and agreed to give up her ESOP account, then valued at $286,904.53. But they did it wrong. The Tax Court explains (citations omitted):

In addition, once a participant’s benefit becomes vested, it is nonforfeitable under ERISA. In sum, a participant in a section 401(a) plan may not assign or alienate his or her benefit, and at the same time, he or she has a nonforfeitable right to that same benefit.

Pursuant to the May 27, 2009, corporate documents, and relying upon the divorce decree, [Wife] transferred 100% of her ESOP shares and relinquished any rights she had under the ESOP. The ESOP’s June 30, 2009 and 2010, reports [*15] reflect that 100% of the shares allocated to [Wife] on June 30, 2009, were reallocated to {Husband’s] account as of June 30, 2010.

Before April 5, 2007, [Husband] and [Wife]… were also [the corporation’s] sole employees and ESOP participants. Although the 2007 divorce decree dissolved the… marriage, it is insufficient to allow the transfer of plan assets that transpired in this case. Transferring the vested shares from [Wife]’s account to [Husband’s] caused [Wife]’s ESOP account to become alienated from her after it became fully vested. By violating section 401(a)(13), the plan ceased to be qualified. Accordingly, we hold that respondent did not abuse his discretion in disqualifying the ESOP for its 2010 plan year and for subsequent plan years.

Public domain image courtesy Wikipedia

Public domain image of Phoenix courtesy Wikipedia

You might wonder why one mistake in one year wrecked everything. Judge Dawson explains:

In general, a qualification failure pursuant to section 401(a) is a continuing failure because allowing a plan to requalify in subsequent years would be to allow a plan “to rise phoenix-like from the ashes of such disqualification and become qualified for that year.”

That’s the frightening thing about going ESOP. You have to comply with extremely detailed and complex qualification rules every year, every time. This requires significant legal and consulting bills, and even then mistakes can be made. While ESOPs can be useful in the right situations, you have to live with serious compliance costs and risks.

In this case, I’m only surprised that the ESOP lasted as long as it did. Section 409(p) imposes a both the UBIT and a 50% excise tax when “disqualified persons” receive an ESOP allocation. Related taxpayers who own more than 10% of the S corporation, or 20% with family members, are “disqualified persons.” In this case the couple owned 100% of the corporation. The case is silent on this issue, but I don’t understand how this structure could have worked even before the disqualification in light of the Section 409(p) rules. The case does say that they terminated their S corporation in 2005, which would have solved the 409(p) problem after that date.

This is the fourth ESOP disqualification the Tax Court has decided involving the individual named as trustee in this case, who I believe had an Iowa-based practice. This continues Iowa’s unhappy history of involvment in bad ESOPs.

Cite: Family Chiropractic Sports Injury & Rehab Clinic, T.C. Memo 2016-10.




William Perez, Secure Ways to Send Tax Documents to Your Accountant. It is reckless and dangerous to send pdfs of your W-2s, 1099s, etc. as an unencryped e-mail attachment. William offers good advice on how to do it right.

Jason Dinesen, Glossary: Compilation. “In the accounting world, the term “compilation” refers to formal financial statements prepared by a public accountant.”

Robert Wood, IRS Forms 1099 Are Coming, The Most Important Tax Form Of All.

Robert D. Flach, 2015 INFORMATION RETURNS. Robert offers a handy chart of the various information returns, except for K-1s.

Russ Fox, Texas Attorney General: DFS Illegal in Texas. “Texas’s Attorney General, Ken Paxton, issued an opinion today that says that daily fantasy sports (DFS) is illegal under Texas law.”



Illustration for early draft Bernie Sanders tax plan.

Illustration for early draft Bernie Sanders tax plan.

Water is wet. Bernie Sanders Is Proposing Really Big Tax Increases (Howard Gleckman, TaxVox).

It is hard to grasp the enormity of the tax increases Bernie Sanders is proposing, how far out-of-step he is with recent economic history in the U.S., and what a stunning contrast he presents with Republican presidential hopefuls.

I love when “enormity” is used correctly unintentionally.

While Sanders describes his top rate as 52 percent, top-bracket taxpayers would be paying up to 58 percent rate (the 52 percent base rate, plus the 2.2 percent health premium, plus the Affordable Care Act’s 3.8 percent surtax on investment income, which Sanders would keep).

Be happy he doesn’t take more, kulaks!

Peter Reilly, Bernie Sanders Tax Plan Moderate On Top Income Tax Rate. Well, I suppose compared to beheading high bracket taxpayers, confiscating their estates, and selling their families into slavery, it is.



Career Corner. Accountant Worked One Day, Allegedly Embezzled $15k (Caleb Newquist, Going Concern). Efficiency!



Tax Roundup, 11/24/15: Another Kansas medical practice ESOP blows up. And: tax credits for everything!

Tuesday, November 24th, 2015 by Joe Kristan

20151124-1When you fund an employee stock ownership plan, be sure you have an employee. Another strange ESOP failure out of Kansas emerged from the Tax Court yesterday. A Wichita doctor, whom we will call Dr. F, funded an ESOP for his practice with over $400,000 in 2004, supposedly rolled over from his IRA. But, according to the tax court, the doctor wasn’t qualified to participate, and there was no evidence of a rollover. From the Tax Court (emphasis added, citations omitted, doctor’s name shortened by me):

Dr. F. received no compensation from, and was not employed by, petitioner in 2004 or 2005. A total of 53.06 shares of petitioner’s stock was allocated to his account in these years. Respondent determined that these contributions exceeded the section 415(c) limitation because Dr. F. received no compensation from petitioner in 2004 or 2005. Petitioner alleges that the amounts in Dr. F.’s accounts were rollover contributions from Dr. F.’s individual retirement account and should not be considered for purposes of section 415(c).

In order for a distribution to be considered a rollover contribution, the entire amount received must be paid into a qualified trust for the distributee’s benefit no later than the 60th day after the day that the distribution is received. Petitioner has not provided evidence that a valid rollover took place. Further, because the ESOP trust did not have a bank or brokerage account from May 13, 2004, through December 31, 2009, it was not possible for the distribution from Dr. F.’s individual retirement account to have been paid into an account held by the ESOP trust.

Details, details. But details are everything. The IRS cited multiple reasons for the ESOP revocation, and as the court notes, “Any one of the reasons cited in the final revocation letter would be sufficient alone to cause the ESOP and the ESOP trust to fail…” The ESOP also failed to get a qualified appraisal.

This is the second physician ESOP out of Kansas to fail this year in Tax Court. Iowa has long been the capital of flaky ESOPs, but Kansas seems ready to challenge our dubious supremacy. In fairness, though, the trustee of both ESOPs appears to operate out of Northeast Iowa, so we’re keeping our hand in the game.

The Moral? ESOPs are useful for limited purposes, primarily as a succession vehicle for a closely-held business, but they are complex and dangerous, requiring meticulous compliance to avoid catastrophe. They are a poor tax shelter for a closely-held business when the owner wants to maintain control.

Cite: Fleming Cardiovascular PA, T.C. Memo. 2015-224


The income tax, the Ultimate Swiss Army Knife of public policy. Flickr Image courtesy redjar under Creative Commons license.

The income tax, the Ultimate Swiss Army Knife of public policy. Flickr Image courtesy redjar under Creative Commons license.

Joseph Thorndike, Tax Credits Are Easy – And a Loser’s Game for Liberals (Tax Analysts Blog):

Hilary Clinton’s presidential campaign is still churning out tax proposals at a furious pace. Over the weekend, she proposed a new credit for caretakers—intended, according to her campaign, to “provide support for the millions of families paying for, coordinating, or providing care for aging or disabled family members.”

That sounds great – just like every other tax break Clinton has suggested in the past several months. After all, caring for family members can be hard, and it’s often expensive. Caretakers could definitely use a hand.

But is the tax system the best way to provide it? Probably not.

Home caregivers are wonderful people. But Mr. Thorndike notes the problems with such feel-good credits:

Using tax incentives as a form of hidden spending merely serves to further erode support for more direct forms of government action. Small-bore tax breaks breed more small-bore tax breaks. But they don’t foster any serious rethinking of the role of government.

Nor do they produce meaningful results, even for the narrow problems they target.

There’s another argument that the tax-credits-for-everything crowd glosses over. Each feel-good credit throws another social program to an IRS that is collapsing under its current workload. They can’t really want IRS agents evaluating at-home care, yet it’s baked into that cake. If you don’t audit a lucrative tax credit, it becomes a fraud magnet. So IRS, meet Grandma.


Howard Gleckman, Clinton’s Caregiver Credit Adds To Her List of Tax Breaks, Sharpens Her Contrast With The GOP. “The likely Democratic presidential nominee, Hillary Clinton, would aggressively use the tax code to achieve social and economic goals, cut taxes on many middle-income people, and raise taxes on high-income households. Every Republican presidential hopeful would eliminate most existing tax subsidies, lower rates, and give big tax cuts to those with high-incomes.”




Robert D. Flach has fresh Tuesday Buzz! Lots of links, and spicy observations on the use of the tax law to run social programs.

Tony Nitti, Tax Geek Tuesday: Reminding You That The Gain On That Sale Of Stock May Be Tax Free. “C corporations are like pit bulls and prostate exams — they carry quite the stigma,  but they’re not nearly as bad as they’re made out to be.”

TaxGrrrl, Guilty On Tax & Conspiracy Counts, Couple Faces New Charges For Revenge. Violating the first rule of holes.

Robert Wood, Al Sharpton’s Charity Hikes His Pay 71%, But Tax Liens, Clinton Imprint Remain.


Farley Katz, Joseph Perera, Katy David, Important New Partnership Audit Rules Change Taxation of Partnerships (Procedurally Taxing)

Not only can the partnership owe income tax, the tax will not be based on the income for the year in question, but instead on one or more prior years’ income. Consequently, the economic burden of the tax could be borne by partners who had no interest in the partnership when the income was generated. Conversely, if a partnership overstated its income in a prior year, the benefit of correcting that overstatement will accrue to the current partners, not those who were partners in the earlier year. Finally, if a partnership elects out of the new provisions (assuming it is eligible), the IRS will no longer be able to conduct a centralized audit controlling each partner’s distributive share, but will instead have to audit each partner individually,

Excellent article. These new rules will change the dynamics of partnership exams a great deal when they take effect for 2017 filings.

Jack Townsend, Fifth Circuit Sustains Convictions Despite Trial Judge’s Refusal to Give Proper Cheek Willfulness Instruction




Tyler Cowen, Against a financial transactions tax. He cites a paper documenting that such taxes are unwise:  “This is consistent with earlier findings on Sweden’s transactions tax, and that proposal continues to be one of the more overrated ideas in American Progressive political discourse.”

TaxProf, The IRS Scandal, Day 929

Peter Reilly, Foundation Of Big GOP Donor Loses Tax Court Case Over Political Ads


Career Corner. Let’s Discuss: Non-Equity Partners in Accounting Firms (Caleb Newquist, Going Concern)



Tax Roundup, 10/6/15: Tax Fairy fails to show up for Kansas ESOP. And: lots of other tax stuff.

Tuesday, October 6th, 2015 by Joe Kristan

tax fairyThe ESOP Tax Fairy Cult has long had Midwest adherents. The Tax Court told gave a Kansas believer the bad news yesterday — there is no tax fairy.

A successful Kansas orthopedic surgeon set up a new corporation, “DNA,”  with his wife. The surgeon and his wife were the only DNA employees. On the day it was incorporated, DNA created an employee stock ownership plan for its employees.

Problems arose. Tax Court Judge Dawson tells the story:

On December 31, 2008, DNA issued 1,150 shares of class B common stock to the trust with a par value of $10 per share. The trust then allocated the 1,150 shares of DNA stock to [the surgeon’s] ESOP account in 2008.

During 2008 DNA did not pay any salaries, wages, or other officer’s compensation. For 2009 DNA issued separate Forms W-2, Wage and Tax Statement, to [the taxpayers] reporting the respective amounts of $4,500 (during its fourth quarter beginning October 1). DNA issued Forms W-2 for 2010 to [the taxpayers] reporting the respective amounts of $3,000.

DNA deducted a $1,350 retirement plan contribution on its Form 1120, U.S. Corporation Income Tax Return, for 2009.

Although DNA was the sponsor of the ESOP, it did not file any Forms 5500, Annual Return/Report of Employee Benefit Plan, for plan years 2008, 2009, and 2010.

The IRS examiners found problems with this and other aspects of the way the ESOP was run (my emphasis):

    In this case, the ESOP had two separate failures to follow its plan document during 2008. First, the ESOP sponsored by DNA… allowed [the taxpayers] to participate in the ESOP as of the plan year ending December 31, 2008, in violation of the terms of the ESOP plan document regarding eligibility and participation. Second, the ESOP plan document required the ESOP to use appraisal rules substantially similar to those issued under I.R.C. sec. 170(a)(1) when it obtained annual appraisals for the same plan year. The ESOP, however, failed to obtain any appraisal for the 2008 plan year or for any plan year.

That led to a bad result:

For the reason stated above, it is determined that the ESOP is not qualified under I.R.C. sec. 401(a) for the plan years ending December 31, 2008 and all subsequent plan years. As a result, the Plan is not exempt from taxation under I.R.C. sec. 501(a) for trust years ending December 31, 2008 and all subsequent plan years.

A Google search reveals that the ESOP reported net assets of nearly $400,000 at the end of 2012. That would mean that much additional income for the ESOP participants over the term of the ESOP.  That’s an expensive sacrifice to the tax fairy. As the ESOP was set up the same day as the corporation, it appears likely that the purpose of the corporation was to feed the ESOP. Iowa has been a hotbed for bad ESOPs. While there is no evidence showing that this is linked to any other bad ESOPs, I note that the corporation had an Iowa mailing address.

The Moral: ESOPs aren’t easy. They can be useful under the right circumstances, but they require appraisals and careful compliance with the plan document an ESOP rules. They aren’t an easy tax shelter, and there is no ESOP Tax Fairy.

Cite: T.C. Memo 2015-195.




It’s Tuesday, so it’s Buzz-day for Robert D. Flach. He rounds up news ranging from the developments in the Section 105 $100-per-day penalty (Tax Update coverage here) to the ongoing problems in keeping EITC from squirting all over the place.

Kay Bell, IRS says ‘No’ to tax-exempt status for pet care group offering heated spa, massages and other animal amenities. My beagle would approve this exemption.

Jason Dinesen, Glossary: MACRS. “MACRS refers to “modified accelerated cost recovery system,” which is the default depreciation method used for tax purposes.”

Russ Fox, Well, That’s One Way to Avoid ClubFed. But fatal heart attacks have serious non-tax drawbacks.

Peter Reilly, Boston Bernie Backers Probably Not Bashing Bruins



Joseph Thorndike, The ‘Cadillac’ Tax Shows Why Obamacare Was Never Built to Last (Tax Analysts Blog). “All of which suggests that Obamacare will be in trouble for a long time.”

TaxProf, The IRS Scandal, Day 880

Joseph Henchman, California Supreme Court to Decide Fate of 48-Year-Old Multistate Tax Compact. (Tax Policy Blog). “Maybe it’s time we accept that the MTC isn’t working, and the Gillette case might be the first step of that realization.”

Renu Zaretsky, Evasion, Cuts, Hikes, and Drops. Today’s TaxVox headline roundup covers a planned “global crackdown” on tax evasion, business tax cuts in New Hampshire, and much more.

Leslie Book, District Court Hands IRS Loss in its Bid to Exclude Discretionary Treaty Benefits From Judicial Review (Procedurally Taxing).

Robert Wood, As IRS And DOJ Hunt Offshore Accounts, Banks Pony Up.


News from the Profession. Oh Great, Public Accounting Discovered the Selfie Stick (Caleb Newquist, Going Concern)



Tax Roundup, 2/25/14: Temporary Permanence Edition. And: Reform week?

Tuesday, February 25th, 2014 by Joe Kristan

20120511-2Some of us just have jobs.  Others have callings.  If you feel you have a calling, it can be very difficult to sway you from your vocation.  Sometimes not even a permanent federal court injunction will do the trick.  

A permanent injunction apparently didn’t stop an Iowan whose calling appears to be to spread the gospel of ESOP.  John L. Henss was already promoting his vision of Employee Stock Ownership Plans when I moved to Iowa as a young CPA in 1985.  By a remarkable coincidence, Iowa had more than its share of tax litigation involving flawed ESOPs over the years (see, for example, here, here and here).

One of the most remarkable cases was the 1992 case of Martin v. Feilen (CA-8, 965 F.2d 660), involving alleged self-dealing and fiduciary breaches among the trustees and administrators of Feilen Meats, an Iowa packer.  Among the defendants was John L. Henss.

Judge Loken authored the decision of the Eighth Circuit on the case, a decision that went badly for Mr. Henss (my emphasis):

Henss was the dominant decision-maker for FMC and the ESOP with respect to all or nearly all the transactions discussed in this opinion. He also holds himself out as an ERISA expert who has structured and provided other services and advice to hundreds of ESOPs. In addition to engaging in the actionable self-dealing we have described, Henss’s trial testimony displayed an appalling insensitivity to the proper role of ESOPs and ESOP fiduciaries. For example, Henss stated repeatedly his view that ESOP fiduciaries are exempt from ERISA’s “prudent man” rule when investing plan assets in an employer’s stock or property.

To summarize, we affirm the district court’s judgment that Henss and Stephen Thielking, and their personal corporations, breached their ERISA fiduciary duties in causing the ESOP to engage in the above-described Transactions Subject to ERISA, and we affirm the district court’s permanent injunction against Stephen Thielking and Stephen K. Thielking, C.P.A., P.C. We modify the permanent injunction against John Henss and John L. Henss C.P.A., P.C., to further enjoin them from acting as a service provider to any ERISA plan. 

So that ended Mr. Henss’ career in the ESOP field, right?  Never underestimate the tenacity of a man with a calling.  His name reappeared in another ESOP case yesterday in Tax Court.  It was a remarkable case, actually, in that a partnership had an Employee Stock Ownership Plan.  But when you have a calling, a lack of a corporation with actual stock won’t stand between you and an ESOP.  But mere tenacity isn’t enough, according to Judge Kerrigan (my emphasis):

Respondent contends that because K.H. Co. was a partnership for tax purposes, it did not have qualifying employer securities. The parties do not dispute that K.H. Co. was a partnership at all relevant times. Indeed, K.H. Co. admits that it filed Forms 1065, U.S. Return of Partnership Income, for tax years ended September 30, 1995 through 2004. Because K.H. Co. was a partnership for tax purposes and did not have any stock, it did not have any qualifying employer securities for purposes of sections 409(l) and 4975(e)(7) and (8) in which the plan could invest. Therefore, petitioner failed to operate as an ESOP pursuant to its terms when K.H. Co. became its employer, sponsor, and administrator. 

But aside from the obvious one, what problems might this ESOP have?  Perhaps the required ESOP stock appraisal, performed for 2000, 2001 and 2002 by none other than John L. Henss.  Apparently “permanent” had already worn off by then.  From the Tax Court:

John L. Henss was chosen to appraise K.H. Co. The administrative record includes appraisals and appraisal summaries for only 2000, 2001, and 2002. Written on “JLH” letterhead, the cover letter of each appraisal states: “At your request, we have prepared an appraisal valuation of KH Company, L.L.C.” The cover letters refer to the “appraised value of common stock of KH Company, L.L.C.” The cover letters are all dated, but none of them are signed.

Mr. Henss’ qualifications are not described in the appraisals. The appraisal summaries state merely: “The undersigned holds himself out to be an appraiser. The undersigned is an accountant who is familiar with the assets being appraised.” Mr. Henss did not sign or date the appraisals or the appraisal summaries. 

     Petitioner claims that Mr. Henss has degrees in English, accounting, and law. Petitioner further claims that Mr. Henss “has been preparing appraisals of stock for employee stock ownership plans for many clients for several years” and that he is the author of a book on ESOPs. Petitioner also contends that Mr. Henss was in all other respects a person who was “independent” as set forth in the statute, the regulations, and the Commissioner’s announcements on the subject.

Section 1.170A-13(c)(5)(i)(A), Income Tax Regs., provides that a qualified appraiser is an individual who includes on the appraisal summary a declaration that he or she holds himself or herself out to the public as an appraiser or performs appraisals regularly. Because there is no signature below the statement on the appraisal summaries that the “undersigned holds himself out to be an appraiser”, the plan failed to meet this requirement. 

Not to mention that he had been enjoined from providing services to ERISA plans — a term that would seem to cover appraisal services.

Whatever the nature of his calling, things haven’t universally gone well in court for clients who have used Mr. Henss.   Perhaps when selecting an ESOP service provider, one might well take federal court injunctions into consideration.

Cite: K.H. Co. LLC Employee Stock Ownership Plan, T.C. Memo 2014-31.


taxanalystslogoIt appears the House GOP will release its tax reform plan today.  Tax Analysts Blog is on it:

Martin Sullivan, Can Dynamic Scoring Save Tax Reform? Don’t Count on It

Jeremy Scott, How to Pay for Camp’s Tax Reform Plan

Clint Stretch, The Tax Reform Blame Game

Renu Zaretsky, House GOP Tax Plan Hits This Week; IRS Getting Worked Over But It’s Still Working.  This is a new daily news roundup at TaxVox.

Tax Justice Blog, State Tax Breaks Pile Up.  Government by special favor always has its fans.


William Perez, Reporting Unemployment Compensation Benefits

S-SidewalkTony Nitti, Tax Geek Tuesday: 2013 Tax Planning Is Not Finished For S Corporations – How To Purge Problematic Earnings and Profits   

Kay Bell, Most taxpayers support tax preparer competency standards.  I find this a meaningless result, a question posed to people who have given approximately no thought to the issue and who have more developed views of Miley Cyrus than John Koskinen.

Peter Reilly,  New Jersey Gets To Second Guess IRS On Estate Tax Marital Deduction 

TaxGrrrl, Pharrell Williams & The Ultimate Charitable Hat Trick   


Liz Malm, Mississippi Lawmakers Consider Firearm Sales Tax Holiday (Tax Policy Blog).  Even for a good cause, sales tax holidays are a bad idea.

TaxProf, The IRS Scandal, Day 292

Is there nothing the tax law can’t do?  Meanwhile in Canada, You Get a Tax Credit For Not Stinking the Joint Up (Going Concern)



Tax Roundup, 1/28/14: Another Iowa ESOP debacle. And: soft skills!

Tuesday, January 28th, 2014 by Joe Kristan

Iowa gets all of the good bad ESOP cases.  
Thanks largely to the energetic work of a single ESOP evangelist in the 1980s and 1990s, Iowa has been treasure trove of cases involving faulty employee stock ownership plans.  The pinnacle of these cases may have been the Martin v. Feilen case, finding violations sufficient for the Eighth Circuit to rule that a district court “abused its discretion” by not banning the Iowa ESOP evangelist from doing any further ERISA work.

Iowa’s bad ESOP history got another chapter yesterday in Tax Court.  The ESOP involved a Rockwell, Iowa S corporation, which had an ESOP owner.  The non-ESOP shares were owned by the corporation’s sole employee and his wife.

So many things can go wrong with this sort of arrangement, and they all did — starting with Sec. 409(p).  Judge Kroupa explains (some citations omitted, emphasis added):

  Responding to perceived abuses, Congress in 2001 enacted section 409(p), which generally limits the tax benefits available through an ESOP that owns stock of an S corporation unless the ESOP provides meaningful benefits to rank-and-file employees.

There are significant tax consequences when an ESOP violates the section 409(p) requirements. For one, an excise tax equal to 50% of the total prohibited allocation is imposed. Sec. 4979A. Furthermore, the ESOP will not satisfy the requirements of section 4975(e)(7) and will cease to qualify as an ESOP. 

Those are pretty severe penalties.  So how do you violate Sec. 409(p)? Roth and Company alum Nancy Dittmer explains:

Section 409(p) is satisfied if “disqualified persons” do not own 50% or more of the S corporation’s “stock.” This stock includes allocated and yet-to-be allocated ESOP shares, synthetic equity of the S corporation, and any shares held directly in the S corporation. The ESOP shares and any synthetic equity are considered to be “deemed-owned” shares for purposes of Section 409(p).

In general, a disqualified person is any ESOP participant who owns 10% or more of the ESOP’s stock. 

20140128-1As our Rockwell taxpayer was the only employee of the S corporation and, by attribution, the only owner of the ESOP, he owned 100% of the shares.  Those of you who are good at math will realize that 100% exceeds 50%, and 409(p)’s excise tax and plan disqualification applies.

So things looked dark for the Rockwell ESOP.  Yet there was a glimmer of hope — not only was the ESOP screwed up, so was the S corporation.  The corporation had 2 classes of stock, which normally disqualifies an S corporation election.  If the corporation isn’t an S corporation, it can’t violate 409(p)!  Alas, Judge Kroupa decided here that two (OK, more than two) wrongs didn’t make a right:

     Petitioner represented to respondent that it qualified as an S corporation for 2002 when it filed its election to be treated as such. Respondent relied on this representation for 2002 because petitioner reported on its 2002 Form 1120S that it owed no income tax because of its electing to be treated as a passthrough entity under subchapter S. The statute of limitations on assessment now bars respondent from adjusting petitioner’s income tax liability for 2002. See sec. 6501(a).

Petitioner was silent regarding its desire to be treated as something other than an S corporation for 2002. Petitioner cannot avoid the duty of consistency, however, by simply remaining silent. Allowing silence to trump the duty of consistency would only encourage gamesmanship and absurd results. Therefore, we will treat petitioner as an S corporation for 2002 under the duty of consistency. 

This bundle of bad facts resulted in $161,200 in taxes and another $76,000 or so in penalties.

The moral?  In spite of media reports, it can be dangerous to game the ESOP rules to avoid tax on S corporation income.  There are many hazards and much legal complication.  If you want to have an ESOP, be sure to bring in a specialist.

Cite: Ries Enterprises, Inc., T.C. Memo 2014-14.


Me: IRS gives mulligan to elect portability for $5 million estate exclusion

Paul Neiffer, Not Too Late to Make Portability Election!  I have more here.

Kay Bell, Decoding your W-2

TaxGrrrl, Do You Need To File A Tax Return In 2014?   


TaxProf, The IRS Scandal, Day 264

Kyle Pomerleau, The U.S. Has the Highest Corporate Income Tax Rate in the OECD (Tax Policy Blog):

OECD corporate rates

And as Iowa has the highest corporate rate in the U.S., at 12%, we’re number 1!  In a bad way.


Robert D. Flach is right on time with your Tuesday Buzz!


Career Corner: Soft Skills Are For Pansies (Going Concern)




Tax Roundup, 1/20/14: If it’s not a scandal, it hurts like one. And: S corporation ESOP play in WSJ.

Monday, January 20th, 2014 by Joe Kristan

The U.S. District Court for the Southern District of Iowa didn’t need my services as a juror this week, so  I will be participating in the Iowa Bar Association webinar this afternoon on new developments for 2014.  It starts at noon.  You can register here and find more information here.   I will join Roger McEowen of the ISU Center for Agricultural Law and Taxation, and Kristie Maitre, IRS Stakeholder Liason for Iowa.


20130419-1If the Tea Party scandal is not a scandal, why would it be so damaging to the IRS?  The TaxProf’s IRS Scandal Roundup for Day 255 has some eye-opening quotes from a high-powered panel from a Pepperdine/Tax Analysts Symposium last week:

Donald Korb (Partner, Sullivan & Cromwell; former IRS Chief Counsel):  I think it is incredibly damaging.  Frankly, I see it as one of the seeds of the next tax shelter era. … And in terms of scandal, I don’t think we really know. We have not been permitted to understand exactly what happened. So, who knows.

George Yin (Edwin S. Cohen Distinguished Professor of Law and Taxation, Virginia; former Chief of Staff, Joint Committee on Taxation):  I think there has been tremendous damage.  Almost without regard to what actually happened.  And I actually despair of finding out what actually happened. …

Donald Tobin (Frank E. and Virginia H. Bazler Designated Professor in Business Law, Ohio State):  I think it is awful. I agree with Don and George.  7 or 8.  I think this is ultimately going to have huge implications. …

Ellen Aprill (John E. Anderson Chair in Tax Law, Loyola-L.A.):  I agree with all of that.  I have myself avoided the word “scandal” because I just don’t know.  And some of the people I know personally.  I don’t think that was their political motivation.  So I’ve used “controversy” and “brouhaha” and everything but tried not to go all the way to scandal. …

Korb: … This is very, very damaging.  Maybe we are at a 9.5

You can already see effects in the reduction of the IRS funding request in the latest budget deal.  While Congress makes the IRS the Swiss Army Knife of tax policy, it continues to cut back its resources.  That can’t end well.  But the GOP sees that the IRS has acted as a tool for its political opponents, and it’s asking a lot for them to fund their opposition.


Robert D. Flach ponders whether the Registered Tax Return Preparer designation could be revived as a voluntary credential.  If any group of preparers can unite behind a voluntary credential with self-administered standards, great.  Just keep the IRS out of it.  It’s a poor use of their resources, and they aren’t to be trusted with that sort of power.


S imageS imageS-SidewalkESOP S corporation strategy.  The Wall Street Journal (Laura Saunders, via the TaxProf) reports on an S corporation that may have found a way to funnel all of its income to a tax-exempt ESOP via restricted stock for the non-ESOP owners.  Paul Neiffer suspects it may be too good to be true.

It would be a hard needle to thread, giving the severe 409(p) excise tax that can apply to allocations of ESOP shares to owners of closely-held S corporation.  If the strategy does win in the courts, I would expect to see legislation to change the result quickly.


Jack Townsend, Eighth Circuit Affirms Offshore Account Related Conviction


Joseph Henchman, What Same-Sex Couples Need to Know This Filing Season  (Tax Policy Blog).  He links to a nice Tax Foundation study that tells how each state is approaching same-sex marriage this filing season.

Roberton Williams, Utah Lets Same-Sex Couples File Joint Tax Returns (TaxVox)

Kay Bell, Girl Scout cookies might be tax deductible.  Unfortunately, only if you don’t eat them.

Russ Fox, The Trouble With Bitcoins: Taxation.  “If you make money with Bitcoins, it is absolutely taxable.”

Jason Dinesen, Issuing 1099s to an Incorporated Veterinarian.  So veterinary services are “medical services.”

So the IRS agrees with Corb Lund.


Tax Justice Blog, Oklahoma Shows How Not to Budget.  “The biggest offender here is one we’ve explained before: the growing trend of funneling general tax revenues toward transportation in order to delay having to enact a long-overdue gas tax increase.”

William Perez, In Honor of Martin Luther King, Jr.  “In 1960, Dr Martin Luther King, Jr., was found not guilty of filing fraudulent state tax returns for the years 1956 and 1958.”  That’s why you don’t want politicized tax enforcement.

TaxGrrrl, Why Justice Matters: The Indictment & Trial Of Dr. Martin Luther King Jr. On Tax Charges   


Annette Nellen, Real revenue sources for tax reform.  “Where can permanent tax increases be generated to offset the desired permanent tax decrease generated from permanent lower rates?”

Good, we need it.  Bloggers = Media for First Amendment Libel Law Purposes (Eugene Volokh).  “To be precise, the Ninth Circuit concludes that all who speak to the public, whether or not they are members of the institutional press, are equally protected by the First Amendment.”

That’s how it should be.

Peter Reilly, Soldier To Tax Accountant – Rachel Millios EA   


News from the Profession.  CPA Exam Pass Rates Basically Went Right Off the Cliff at the End of 2013 (Going Concern).  


Tax Roundup, 10/26/2012: Central Iowa ESOP flunks out in Tax Court. And lots more!

Friday, October 26th, 2012 by Joe Kristan

What is it about Iowa and ESOPs?  Iowa seems to have more than its fair share of tax litigation involving Employee Stock Ownership Plans. (See here, here, and here for examples)  Iowa’s unusual prominence in this obscure area of the tax law is due in part to a group of Iowa accountants who pushed the plans heavily in the 1970s and 1980s, touting “The Miracle of ESOP.”

An Iowa ESOP will need a miracle on appeal after being revoked retroactively yesterday by the Tax Court.  Judge Gerber upheld the 2010 revocation of the plan back to 1995 for several reasons, including failure to timely amend plan documents for tax law changes and failure to get a properly-documented appraisal of the ESOP stock.

Judge Gerber discussed the appraisal problem:

     Thielking was the person selected to appraise common stock of a company’s employee stock ownership plan (ESOP) in another case before this Court. In that case, involving similar taxable years, this Court addressed Thielking’s failure to set forth his qualifications as follows:

Petitioner asserts that Thielking was a permissible appraiser of the ESOT’s stock in petitioner. We hold otherwise. Section 401(a)(28)(C) provides that all employer securities which are not readily tradable on an established securities market must be valued by an “independent appraiser”. Since petitioner’s stock is not traded on an established securities market, an independent appraiser had to value the ESOT’s holdings of that stock. As relevant here, an “independent appraiser” means a “qualified appraiser” as defined by section 1.170A-13(c)(5)(i), Income Tax Regs.

The ESOP fails at least two requirements of that section. First, section 1.170A-13(c)(5)(i), Income Tax Regs., requires that the appraisal summary contain a declaration that the individual holds himself out to the public as an appraiser. The appraisal letters covering the 2001 through 2003 plan years state that “The undersigned holds himself out to be an appraiser”. However, there is no signature below that statement on any of the letters (there is an unsigned line for a signature with the word “appraiser” typed below). Second, section 1.170A-13(c)(3)(ii)(F) and (5)(i)(B), Income Tax Regs., requires that the qualified appraiser who signs the appraisal must list his or her background, experience, education, and membership, if any, in professional appraisal associations. The appraisal here is not signed, and the appraisal summary does not list the referenced information.

Hollen v. Commissioner, T.C. Memo. 2011-2, slip op. at 9-10, aff’d, 437 Fed. Appx. 525 (8th Cir. 2011). Thielking’s failure to set forth his qualifications was part of the basis for this Court’s holding that the common stock in that case was not appraised by a “qualified appraiser”.

     The circumstances in Hollen were substantially similar to the circumstances in this case.

The appraiser in this case once was associated with a man who told a client I worked with in the 1980s that (I paraphrase) “Sure, you can use a fancy-pants appraiser and spend a lot of money.  You can also use an expensive lawyer for a divorce or you can file your own papers.  You’ll be just as divorced, and you’ll save the legal fees.”  That apparently works about as well in ESOPs as in contested divorces.

ESOPs can be great tools, but they are not easy to use.  15 years of plan disqualification is likely to be pricey.



Wonder what wind energy credits are really all about?   Investors Worth $800 Billion Lobby for Wind Energy Tax Credit (Environment News Service)

Unintended but entirely predictable consequences of refundable credits. Investigators: Child tax credit allows fraudsters a chance to cheat (

TaxGrrrl,   IRS Announces Increase In Annual Exclusion For Gifts, Rest Remains a Mystery

Anthony Nitti,  The Top Ten Tax Cases of 2012: #10 -The IRS Wages War With The Medicinal Marijuana Industry

Trish McIntire,  Playing Chicken With a Career

Patrick Temple-West,  Essential reading: CEOs call for deficit action, and more (TaxBreak)

Martin Sullivan,  A Watershed Moment: CEOs Say Raise Taxes.  (  They are free to write their own checks any old time.


Brutal Assault on Reason Watch: 

Howard Gleckman,  What Is Barack Obama’s Tax Plan?

Kay Bell,  What happens if the electoral vote is tied?

Linda Beale,  Romney, Family Business, Carried Interest, and potential conflicts of interest


It’s five o’clock somewhere, so catch tomorrow’s Buzz today at Robert D. Flach’s place!

I have lots of ideas.   How Not to Spend Tax Revenues (Jim Maule)

News you can use. Toilets Are a Funny Thing (


IRS: you aren’t allowed to escape our trap!

Tuesday, June 19th, 2012 by Joe Kristan

Flickr image courtesy Woodswalker under Creative Commons license

A bunch of McDonalds franchisees in Utah were run in a multy-entity structure: the restaurants were operated in one corporation, while a management company provided payroll, training and benefits services to the restaurants to the operating company.  In 2002 they began working with a consultant who advised them to make an S election for the management company and start an ESOP in it.  The management company also began a non-qualified deferred comp plan for the highly-compensated employees of the managmeent company.

The ink had barely dried on the new structure when the IRS issued new regulations that pretty much wrecked it all.  New rules on S corporation ESOPs, combined with the deferred comp plan, changed everything, as the Tax Court explains (my emphasis):

 On July 21, 2003, the Commissioner issued temporary regulations under which, for the first time, the definition of synthetic equity under section 409(p)(6)(C) included employee balances under nonqualified deferred compensation plans such as the NQDCP which petitioners had established within the management company…

Where the deemed-stock ownership tests of section 409(p) are violated, there are significant consequences to the disqualified persons, to the S corporation, and to the ESOP. Prohibited allocations in favor of disqualified persons are treated as currently taxable to the disqualified persons, sec. 409(p)(2)(A), and excise taxes equal to 50% of the total prohibited allocations are imposed on the S corporation, sec. 4979A. Further, the ESOP will not satisfy the requirements of section 4975(e)(7) and will cease to qualify as an ESOP.

But other than immediate tax, a 50% penalty tax, and ESOP termination, the structure would work just fine.  So the franchisees went back to the drawing board.  They bought the management company stock back from the ESOP. paid out the deferred comp balances of about $3 million, and terminated the ESOP under their own terms.  The taxpayers pretty much undid their plan and went back to their old setup.  But the IRS had another surprise:

On audit respondent determined that petitioners’ July 12, 2004, purchase and acquisition from the ESOP of the stock in the management company occurred for the principal purpose of avoiding or evading taxes by obtaining a loss deduction to which petitioners would not otherwise have been entitled, and respondent disallowed under section 269 the approximate loss deduction of $2,969,000 petitioners claimed.

They weren’t even joking.  Now Sec. 269 is a very obscure and rarely used tool in the IRS terror kit.  In the rare cases when it is used, it usually involves C corporations trying to buy net operating losses or tax credits.  I have never heard of it used on an S corporation, and the Tax Court seemed surprised too:

Respondent acknowledges that because S corporations are passthrough entities for Federal income tax purposes and do not keep their own deductions and losses (i.e., S corporation deductions and losses automatically pass through to the shareholders), it is extremely rare that the Commissioner would seek to make a section 269 adjustment in the context of a taxpayer’s acquisition of an S corporation.

The Tax Court sensibly saw things the taxpayers way.  The judge pointed out that the taxpayers would have been stuck with a bad tax structure caused by IRS rules adopted after they had already set it up (citations omitted):

The above transactions and steps clearly were related and planned as part of an effort to avoid problems created for petitioners by the Commissioner’s temporary regulations, to restructure the management company, and to terminate the ESOP; but they represent valid and real transactions with economic effect that require our recognition as legitimate business transactions.

It’s disturbing to see the IRS try to use Sec. 269 here.  Every ownership structure is tax-motivated in one way or another.  To challenge  a taxpayer’s entity structure is an improperly tax-motivated transaction, absent some weird result like a windfall tax loss or credit, is grossly improper.  This kind of position would result in penalties if taken by a taxpayer.  Taxpayers should be able to collect a similar penalty from the IRS when the agency litigates abusively like this.

Cite: Love, T.C. Memo 2012-166


Fields of dreams and cash cows: the Iowa legislature at work on the tax law

Friday, March 23rd, 2012 by Joe Kristan

Fields of Dreams: The Iowa General Assembly is poised to pass a sales tax giveaway for a “Field of Dreams” athletic complex at the site where the Kevin Costner movie was shot.  The deal is similar to one set up for the Newton race track, allowing them to charge sales tax but keep it for themselves.  The legislature is charging ahead despite wise warnings against it:

“I think it’s a very dangerous road to go down,” Iowa House Ways and Means Chairman Tom Sands, R-Wapello, told “The state started down that road just a little bit with the racetrack, and now, here are two other proposals that are coming off of that. So the next question is, so where will this end?”

If it’s anything like the film tax credit program, supported with even more enthusiasm in the legislature, it will end in scandal, embarrassment and disgrace.

100% state funding for “innovation.” The “Economic Growth/Rebuild Iowa” committee voted for HSB 648, increasing a 20% tax credit for investments in a “innovation fund” to 100% (100 freaking percent) for a three-year period.  The credit would ratchet down to 75% the next year, then 50% for a year, before returning to 20%.  The tax credits could be sold.    This means that “investors” in the fund would be fully subsidized by you and me, but the profits will be private.  Downside to us, upside to them.  What could possibly go wrong?

Special tax break for executive stock bonuses.  The Iowa House Ways and Means Committee is considering HF 2311, a bill that would provide a one-time election to not pay Iowa tax on gains from stock received by employment, if you work for the right company.  Because of the way it is written, it would apply mostly to executives of big companies.  Because Iowa needs a special tax exemption for executives of big companies with big stock gains more than just about anything.

ESOPs. Meanwhile, HF 2284, creating a special tax exemption for certain stock sales to employee stock ownership plans, hasn’t moved since arriving in the Senate Ways and Means Committee two weeks ago.  Is it possible that the legislature will actually refrain from passing a narrowly-crafted tax break?

Instead of trying to shovel our money to all of these narrowly targeted and well-lobbied interests, it would be far better to just give us all a simple system with low rates.  I’d hate for the legislature to go into overtime, but it would be worth it if the result was enactment of the Quick and Dirty Iowa Tax Reform Plan.


Waterloo Dentist ESOP meets its Waterloo

Wednesday, January 5th, 2011 by Joe Kristan

An Iowa dental professional corporation is learning that Employee Stock Ownership Plans aren’t for the faint of heart. The Tax Court yesterday allowed the IRS to strip the corporation’s ESOP of its tax-exempt status going all the way back to 1987. Tax Court Judge Laro lays out the background:

Petitioner is a professional corporation that reports its income and expenses on the basis of the calendar year. It employs its principal shareholder, Michael C. Hollen (Dr. Hollen), as a dentist and as a corporate officer. Its principal place of business was in Iowa when the petition was filed.
Petitioner began sponsoring the ESOP on November 1, 1986.2 The ESOP’s administrator is Dr. Hollen; he also is the ESOT’s trustee. The ESOP’s plan year initially ended on October 31 but was changed in 2001 to end on December 31. As of its plan year ended December 31, 2002, the ESOP had 15 participants and/or beneficiaries.
The ESOT’s primary asset was stock in petitioner.

The Tax Court ruled that the plan was disqualified for four separate reasons, each of which by itself could be grounds for disqualification:
– It failed to amend its plan document to keep up with tax law changes.
– It failed to credit participant accounts under the plan vesting schedule.
– It failed to use an independent appraiser
– It allocated amounts to the dentist in excess of the amounts allowed under the tax law.
Many ESOPs were set up in Iowa in the 1980s by a former associate of this ESOPs’ appraiser; the case doesn’t say whether this is one of them, though the timing of the plan set-up coincides with that associate’s career. That associate was later enjoined from ERISA practice by the Eighth Circuit. Perhaps not coincidentally, Iowa has been a hotbed for ESOP litigation (see here and here, for example). Some of these ESOP companies have learned the hard way that while they have important tax advantages, ESOPs exact a considerable compliance cost — and if you don’t pay that cost, the consequences can be severe. It’s daunting to imagine the income and excise tax cost of an employee plan disqualified all of the way back to 1987.
Cite: Michael C. Hollen DDS PC, T.C. Memo. 2011-2


Coverage rules bring down doctor’s ESOP

Thursday, August 5th, 2010 by Joe Kristan

A Houston Plastic surgeon, Dr. Scott Yarish, got an offer to sell one of his five medical practice businesses. His lawyer, a Mr. Riddle, got to work, recommending an S corporation owned by an ESOP to shelter sale proceeds and other business income, as the Tax Court explains:

He advised Dr. Yarish to form an S corporation to manage his four medical practice entities as well as the medical practice Dr. Pisarki sought to purchase. The medical practice entities would pay a “consulting fee” to the S corporation and then deduct the fees as management services.
Mr. Riddle further recommended that the S corporation sponsor an ESOP to defer income earned by the S corporation. It was intended that the income of the S corporation would pass through to the ESOP, and, because the ESOP would be tax exempt, it would pay no tax on the income until it was distributed to the ESOP participant. Dr. Yarish would be the sole ESOP participant. In effect, Dr. Yarish’s medical practice entities would divert money to an entity owned by a tax-exempt trust, creating a substantial cash and property benefit solely for Dr. Yarish.

A cunning plan. Unfortunately for the doctor, ESOPs are “qualified plans.” To keep employers from funding lavish plans for owners or executives while leaving out other employees, the qualified plan rules have “coverage requirements.” These often complex rules require that non-highly compensated employees be covered as well as the big shots, and the testing for these rules is done across related-employer groups. Still, all worked out well, until…
Respondent audited the ESOP after the ESOP terminated. Respondent’s examination concerned whether all eligible employees of Dr. Yarish and his medical entities participated in the ESOP. Respondent sought documents from petitioner regarding the ESOP. Petitioner provided respondent with, among other things, a list of related entities and a census of employees in the controlled group or affiliated group. These documents contradicted petitioner’s statement in its application that it was not a member of an affiliated service group or a controlled group of corporations under common control.

Now things went badly. The IRS retroactively revoked the “determination letter” stating that the ESOP failed to disclose its affiliated group status when it applied for the letter. That has all sorts of horrendeous potential consequences, including the loss of deductions and civil penalties. The Tax Court upheld the IRS.
The moral? Don’t set up a tax-advantaged qualified plan, like an ESOP or profit-sharing plan, with the expectation that you can leave employees out, even by putting the employees in a separate company. When you do set up a qualified plan, work with somebody who does qualified plan work for a living, and make sure they know about all of the business interests of the owners.
Yarish Consulting Inc., T.C. Memo. 2010-174
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Sorting out the Tribune Mess

Monday, June 8th, 2009 by Joe Kristan

Real estate mogul Sam Zell tried to work his magic on the Chicago Tribune. Chapter 11 quickly ensued, and now the meter is spinning frantically as a raft of professionals work to sort out how to turn the company over to creditors without committing a tax disaster.
Today a good article in the Trib itself lays out just how complex the restructuring could be:

Tribune Co. employees own 100 percent of the company’s equity through an arcane, tax-advantaged corporate structure known as an S-Corp ESOP. But a tangle of S-Corp rules would make it difficult to give the senior lenders equity and maintain the S-Corp structure.
Among other things, an S-Corp can have only 100 shareholders, and they must be individuals, not corporations. A retirement plan like an ESOP, which can have thousands of members, is permissible. But a lender like JPMorgan would be prohibited, and Tribune Co.’s senior lender group has more than 100 members anyway.
Zell’s team has argued to creditors that keeping the S-Corp structure adds value to the company. It shelters Tribune Co. from paying income taxes and facilitates the company’s ability to spin off assets without paying capital gains taxes. Last year, for instance, the structure helped Zell’s team construct a tax-advantaged deal to unload Newsday newspaper in New York for $650 million. It also is figuring prominently in plans to shelter Tribune Co. from a big tax bill stemming from its pending sale of the Cubs.

The article explains that the S corporation could drop the assets into a partnership with the S corporation staying in existence as a partner, but then you have to figure out how to get funds to the S corporation to pay the loan it probably has taken out to buy Tribune stock.
Even with the best of counsel, there will be tax risks in this complex structure. In 2005 The Trib lost a billion-dollar case involving its sale of Matthew Bender. The IRS is already examining their ESOP structure for the possibility that it was an improper setup to begin with.
Bankruptcy counsel. ESOP attorneys. S corporation mavens. Partnership tax experts. We’re not talking cheap, especially at Chicago rates. And no matter how much you pay the professionals, you still don’t solve the big problem: how you make money with a newspaper in the era of Craigslist and internet via mobile phones.
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You mean buying stock of a doomed company is a less-than-prudent investment?

Monday, May 18th, 2009 by Joe Kristan

The IRS has started an exam of the Chicago Tribune that could make folks reluctant to do ESOP acquisitions, especially when a struggling company is involved:

Under scrutiny is a $250-million purchase of Tribune shares in April 2007 by the company


Owning plenty of nothing

Monday, December 8th, 2008 by Joe Kristan

Sam Zell took control of the Tribune Company, owner of the L.A. Times and Chicago Tribune, via a highly-leveraged ESOP-owned S corporation last December. Today the Tribune Company entered Chapter 11.
Sometimes when employees are handed shares of employer stock, they just end up holding the bag.