C corp, which does not have registered securities, sponsors ESOP. C corp shareholders are considering making an S election. With respect to shares held by the ESOP, does voting on the S election have to be passed through to ESOP participants? Is the S election a "reclassification" under Section 409(e)(3)?

The shareholder consent required for an S corporation election is not a corporate matter presented to shareholders for a vote. Each shareholder of record makes an individual decision as to whether to consent. The corporation's decision to elect S corporation status is made made by the board of directors.

Accordingly, as there is no matter presented for a shareholder vote, there is nothing to "pass-through" to ESOP participants under IRC Sec. 409(e)(3).

Thanks for the response. As I understand it, you're distinguishing between a voting right (presumably a corporate governance issue and a matter of state corporate law) and the consent requirement (a tax code issue). Logically that makes sense, but I wonder if you have seen any IRS authority for this proposition?

I'm not aware of any "official" IRS position on this point.....although there is a mid-1990's TAM (involving an ESOP corporate reorganization) which states that the voting pass-through requirement of IRC Sec. 409(e)(3) is triggered only when the applicable corporate law requires a shareholder vote on a matter.

It is clear that consent to an S corporation election is not a shareholder vote.....for example, each shareholder must consent, consent is by each individual shareholder not on a per share basis, etc.

It would seem to me that the decision by the trustee whether or not to consent to the election of S Corporation status would be a fiduciary act subject to ERISA.