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Washington, DC:  An Eighth Circuit panel on Tuesday affirmed a Tax Court ruling that the Employee Stock Ownership Plan of an orthopedic surgeon's corporation — which employed only him and his wife — did not quality for a tax exemption because it failed to meet requirements.

The appellate court affirmed the right of the IRS to disqualify the ESOP from tax exemption because the company Dr. Daniel Prohaska started with his wife as vice president and secretary in 2008 contributed stock to the doctor even though he received no compensation that year, thus exceeding corporate contribution limits set by the tax code.

The company, DNA Pro Ventures Inc., appealed multiple prongs of the Tax Court's disqualification, but the ruling noted that the IRS needed only one ground to disqualify the plan so it did not address allegations that the couple failed to have the stock's value annually appraised. The opinion, written by Judge James B. Loken, also noted that once a plan has been disqualified, it remains so "until remedial action is taken."

"Here, there is no evidence DNA or the ESOP took corrective action," the ruling said. "Accordingly, the commissioner did not abuse his discretion in disqualifying the ESOP for 2008 and the subsequent plan years in question. The decision of the Tax Court is affirmed."

After initiating a review in November 2011, the IRS notified DNA in November 2012 that its ESOP's Trust was not part of a qualified pension, profit-sharing or stock bonus plan from 2008 through 2011. In 2014, the IRS sent its final nonqualification letter explaining the ESOP was disqualified for two failures to comply with the plan document and for making contributions to employees exceeding compensation in 2008.

DNA challenged the determination in Tax Court, but in October 2015 the late Judge Howard A. Dawson determined that the plan was not exempt because it had been disqualified on multiple grounds and that the IRS did not abuse its authority.

The Tax Court case and appeal were decided without trial based on facts stipulated to the record by both sides. According to the opinion, on the day of incorporation, DNA issued 50 shares of class A common stock to Daniel Prohaska, the plan trustee, and 50 more to his wife at a par value of $50 per share.

The Tax Court found that DNA had issued 1,150 shares of class B common stock to the trust in 2008. The Class B shares allocated to Daniel Prohaska. But DNA then attempted to rely on documents not in the record, arguing that the Tax Court "got the facts wrong" because the ESOP purchased the shares from DNA on the day of incorporation with a loan.

"Nothing in the record shows a contribution by Dr. Prohaska to the ESOP or an allocation to his ESOP account in the trust in 2008. In fact, the ESOP repaid the loan and allocated the shares to Dr. Prohaska in 2009," the opinion said, noting that the supporting documents "were not part of the parties' stipulated administrative record" in the Tax Court case. "Therefore, these documents are not part of the record we may consider on appeal to this court."


As seen in Law360.  By Kyle Jahner.