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S CORPORATIONS

treated his split-dollar benefits as a Sec. S corporations. Sec. 1378 and his C corporation law firm to a related
1368(b) distribution, which would have § 1.1378-1(a) provide that the tax- S corporation using creative accounting,
been tax-free to the extent of his outside able year of an S corporation must according to the Tax Court.
basis, and capital gain on the excess, be a permitted year. The term “per- Until 2011, Ryder offered a staffing
if any. mitted year” means (1) the required services product where he would estab-
taxable year (i.e., a taxable year lish an ESOP-owned S corporation that
Sec. 1378: Tax year of ending on December 31), (2) a tax- would acquire a client’s employees and
S corporation able year elected under § 444, (3) a then lease them back to the client. Any
Under Sec. 1378, the tax year of an 52–53-week taxable year ending with profits flowing through the S corpora-
S corporation must be a permitted reference to the required taxable year tion to the ESOP would not be taxed
year. A permitted year is the calendar or a taxable year elected under § 444, and would provide a retirement benefit
year, a valid tax year elected under Sec. or (4) any other accounting period for employees. The clients themselves
444, a 52–53-week tax year ending for which the corporation establishes would serve as entity officers and trans-
with reference to the required tax year to the satisfaction of the Commis- fer funds from their business to the
or a tax year elected under Sec. 444, sioner a business purpose. ESOP-owned S corporation. A percent-
or any other accounting period for age of the money was “sluiced” to Ryder
which the corporation establishes to The Chief Counsel took the position in addition to a documentation fee, the
the satisfaction of the IRS a “business here that a change in accounting period court said. This product produced over
purpose.”35 simply to get a refund sooner than $6 million for his law firm. Ryder then
usual (even recognizing the sympathetic assigned the income from his law firm
Expediting refund not a valid nature of this case) was not a business to another shell entity he owned.
business purpose to change purpose that would satisfy the IRS. As a result of “incorporation-palooza
accounting period in early 2001,” Ryder had hundreds
In Chief Counsel Advice (CCA) Sec. 409: Qualifications for of shell S corporations at the ready
202141023, the IRS decided that an tax credit employee stock for which he was sole director, vice
inquiry by an S corporation exploring ownership plans president, and general counsel, while an
the possibility of obtaining a “refund Sec. 409 provides the rules for an em- employee of his legal firm was appointed
sooner than usual” by changing its ployee stock ownership plan (ESOP). vice president of ESOP administration.
accounting period was not a “viable Sec. 409(p) is an anti-abuse provision The mass incorporation was apparently
solution.” Because the taxpayer already targeting the use of ESOPs to accrue an attempt to establish these entities
had a Dec. 31 year end, the taxpayer certain tax benefits to a concentrated before they would be required to have
would need to change to some other group of individuals. more than 10 participants under a new
accounting period but would need to ESOP anti-abuse provision.37 For ac-
establish a business purpose that would Shifting of income to abusive cess to one of the S corporations and its
satisfy the IRS as required under Sec. ESOP-owned S corporation ESOP owner, clients would hire Ryder
444 and the regulations thereunder. disallowed for his general counsel services. Similar
The CCA cited Rev. Proc. 2006-46, In Ryder,36 the taxpayer, a tax attorney to his staffing product, Ryder would
which provides the exclusive procedures and former CPA, spent 20 years lever- charge clients a documentation fee and a
for obtaining automatic approval to aging his ERISA expertise to develop percentage of operating revenue.
adopt, change, or retain an annual and market six tax-reduction strategies, Despite the fact that this initial strat-
accounting period by various types among them two products that used egy quickly earned the status of listed
of taxpayers including S corporations. ESOP-owned S corporations: a staffing transaction due to the lack of substantial
Specifically, the pertinent section of services product and a general counsel benefits or participation by initial ESOP
the revenue procedure (§2.01(3)(c)) office product. Additionally, Ernest participants,38 Ryder was not deterred
provides: Ryder attempted to shift income from and moved forward with a similar plan

35. Sec. 1378 and Regs. Sec. 1.1378-1(a). 37. See Sec. 409(p).
36. Ryder, T.C. Memo. 2021-88. 38. See Rev. Rul. 2003-6.

32 July 2022 The Tax Adviser