On January 14, 2008, the U.S. District Court for the District of Minnesota issued a ruling in General Mills Inc. & Subsidiaries v. United States that distributions to employee stock ownership plan (ESOP) participants from the proceeds of redemptions of company stock held by the ESOP qualified as deductible “applicable dividends” under section 404(k)(1) of the Internal Revenue Code. General Mills established an ESOP, the assets of which were invested in the company's common stock. When a participant terminated employment with the company, the ESOP was obligated to distribute to the participant the value of his or her ESOP account, either in stock or in cash at the participant’s election. In some cases in which a participant elected to receive the value of his or her ESOP account in cash, the Trust distributed to the participant cash that it had obtained from dividend-equivalent redemptions of company stock. Section 404(k)(1) allows a deduction for “applicable dividends,” which include ESOP distributions to participants from the proceeds of dividends paid on company stock held by the ESOP. General Mills claimed that the distributions to participants of the proceeds of dividend-equivalent redemptions of company stock held by the ESOP were deductible under section 404(k)(1). The government raised numerous objections to these deductions, but the district court held for the company. A government appeal to the U.S. Court of Appeals for the Eighth Circuit is expected.
Taxpayers that have established ESOPs should determine whether distributions to ESOP participants were made using the proceeds of redemptions of company stock held by the ESOP. If so, taxpayers should consider filing protective claims for refunds for all open tax years to preserve the right to seek such deductions.