LLC unit shares qualify as ESOP employer securities

Plain-English summary

An LLC taxed as an association and S corporation planned to establish an employee stock ownership plan. Its ownership units carried identical dividend and distribution rights, and the operating agreement would be amended to give every unit identical voting rights. The company also represented that it had no employer securities readily tradable on an established market. The IRS ruled that the units were employer securities under section 409(l)(2) for ESOP purposes, assuming the promised operating-agreement amendment was made.

Ruling snapshot

• Question: Did the LLC's unit shares qualify as employer securities for its proposed ESOP?
• Outcome: Approved
• Key authorities: IRC §§ 409(l)(2), 4975(e)(7)-(8), 7701(a)(3), 7701(a)(7)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224
Number: 201538021
Third Party Communication: None
Release Date: 9/18/2015 Date of Communication: Not Applicable

Index Number: 409.01-09 Person To Contact:
-------------------, ID No. -----------------
---------------------------------------------- Telephone Number:
---------------------------------------------- --------------------
-------------------------- Refer Reply To:
------------------------------------ CC:TEGE:EB:QP3
PLR-T-103082-15
Date:
June 18, 2015

Legend

Company A = -------------------------------------------------------------------------------
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Company B = -------------------------------------------------------------------------------
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Company C = -------------------------------------------------------------------------------
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Company D = -------------------------------------------------------------------------------
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Operating Agreement = -------------------------------------------------------------------------------
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State = -------------

Dear ----------:

This letter is in response to a request for a ruling, submitted on your behalf by your
authorized representative on April 14, 2014, as supplemented by letters submitted on
January 12, 2015, and June 11, 2015, concerning whether the unit shares of Company
A constitute employer securities within the meaning of section 409(l)(2) of the Internal
Revenue Code (“Code”). The following facts and representations have been submitted
under penalty of perjury in support of the requested ruling:

PLR-T-103082-15 2

Company B was incorporated under the laws of State in 1960 and elected, in
accordance with section 1362, to be to be taxed as an S corporation for federal income
tax purposes effective January 1, 1991. In December 1994, Company A, a limited
liability company (LLC), was formed under State law and Company B merged into
Company A with Company A surviving the merger under state law. Company A
represents that the merger qualified as a reorganization under section 368(a)(1)(F). For
federal tax purposes, Company A represents that it is classified as an association and
has a valid S corporation election.

In 1973, Company B founded Company C as an expansion of one of its divisions.
Company C was organized as a partnership between Company B and Company D on
January 1, 1991, with Company D owning one unit share of Company C. In 1998,
Company C, in a state law merger, converted from a partnership to a limited liability
company taxable as a partnership for federal income tax purposes.

On December 29, 2014, the following events occurred, effective January 1, 2015:
Company C elected to change its status from a limited liability company taxable as a
partnership for federal income tax purposes to an association taxable as a corporation;
Company A (the successor to Company B) purchased from Company D its one unit
share of Company C; and Company A elected to treat Company C as a qualified
subchapter S subsidiary (Q sub) under section 1361(b)(3).

Under section 2.1 of the Operating Agreement, ownership interest in Company A is
represented by unit shares (“Unit Shares”). The Operating Agreement provides in
section 2.4 that all profits and losses of Company A shall be allocated among the
shareholders in proportion to the number of Unit Shares owned by them, and that all
dividends shall be paid to shareholders in proportion to the number of Unit Shares
owned by each shareholder.

Company A made the following representations in a letter dated June 11, 2015:
The Operating Agreement provides that all Unit Shares confer identical rights to
distributions, dividends and liquidation proceeds, and will be amended to provide that all
Unit Shares have the same voting rights and otherwise meet the requirements of
section 409(l)(2). Company A further represented that it has no authorized, issued, or
outstanding employer securities that are readily tradable on an established securities
market within the meaning of section 409(l)(1).

Company A intends to adopt an employee stock ownership plan as described in section
4975(e)(7) (“ESOP”). Company A intends that employees of Company A and Company
C will be eligible to participate in the ESOP.

PLR-T-103082-15 3

Based on the above facts and representations, Company A requested a ruling that the
Unit Shares of Company A are employer securities as described in section 409(l)(2) for
the purposes of section 4975(e)(7).

Section 4975(e)(7) defines an ESOP as a defined contribution plan which is a stock
bonus plan which is qualified, or a stock bonus and a money purchase plan both of
which are qualified under section 401(a), and which are designed to invest primarily in
qualifying employer securities; and which is otherwise defined in regulations prescribed
by the Secretary.

Section 4975(e)(8) defines the term “qualifying employer security” as any employer
security within the meaning of section 409(l).

Section 409(l)(1) generally defines “employer securities” as common stock issued by
the employer (or by a corporation which is a member of the same controlled group)
which is readily tradable on an established securities market. Where there is no readily
tradable common stock within the meaning of section 409(l)(1), section 409(l)(2) states
that 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.

Section 7701(a) provides definitions of certain terms as they are used in the Code,
where not otherwise distinctly expressed or manifestly incompatible with the intent of
the Code section in which the term is used.

Section 7701(a)(3) states in pertinent part that the term “corporation” includes
associations.

Section 7701(a)(7) states in pertinent part that the term “stock” includes shares in an
association.

Company A represented that it has no employer securities within the meaning of section
409(l)(1). Therefore, the special rule of section 409(l)(2) becomes applicable.
Company A is classified as an association for federal income tax purposes and,
therefore, Unit Shares in Company A are treated as shares of stock. Company A
represented that the Operating Agreement provides that all Unit Shares have identical
dividend rights and, after it is amended, that it will provide that all Unit Shares have
identical voting rights and otherwise meet the requirements of section 409(l)(2).

Accordingly, based on the facts and representations submitted by Company A, we
conclude with respect to the requested ruling that the Unit Shares of Company A are

PLR-T-103082-15 4

employer securities as described in section 409(l)(2) for the purposes of section
4975(e)(7).

This letter ruling is based on the assumption that the Operating Agreement will be
amended to provide that all Unit Shares have the same voting rights and otherwise
conform with the requirements of section 409(l)(2).

This letter ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

The information contained in this letter ruling is based on the information and
representations submitted by your authorized representative on your behalf and
accompanied by a penalty of perjury statement executed by an appropriate party. While
this office has not verified any of the material submitted in support of the request for
ruling, it is subject to verification on examination.

Except as specifically set forth above, no opinion is expressed or implied concerning the
federal tax consequences of the proposed transaction under any other provision of the
Code or regulations.

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to each of your authorized representatives.

                                       Sincerely,


                                       John T. Ricotta
                                       Chief, Qualified Plans Branch 3
                                       (Tax Exempt & Government Entities)

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