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Allocation of Dividends


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Does anyone have an ESOP client (unleveraged) that allocates dividends on any basis other than share balance (e.g. comp or hybrid).  If so, has the client survived an IRS/DOL examination without challenge?

We have one takeover client that allocates dividends based on comp (and am anecdotally aware of others that do so).   While the client negotiated the allocation language with the IRS and was issued a favorable DL, the plan hasn't been subject to a more rigorous audit/examination.

Grateful for any insights and comments!

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I am curious why do they want to allocate the dividends on comp?

To me it make as much sense as saying in a balance forward PSP let's allocate all the earnings on the investments on comp instead of balances. 

I can't cite anything one way or another but I am not sure I have seen ALLOCATED dividends done this way.  I have seen crazy things with unallocated dividends. 

The only real question I would have is this causes everyone's stock to have a different dividend rate.  ESOPs are supposed to have stock that gets the same dividend rate as any outside shareholders.  This would be true in the aggregate but not true by person and that makes me uncomfortable at a minimum. 

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Appreciate the responses.

ESOP Guy - In instances I've seen, the comp allocation was implemented where a mature, majority S corp ESOP (e.g., 80%) has a serious 'have/have not' issue, little employee turnover, and receives a very significant earnings distribution each year, compounding the issue.

Understanding the different dividend rights issue and single class of stock requirement, I always fall back on the fact that the trust is the shareholder of record.  So provided the trust receives its required pro rata distribution, neither the Code, ERISA or state corporate law dictates/restricts how the dividend can be allocated to participants inside the ESOP.   Also numerous PLRs in which the IRS has held excess unallocated shares following repayment of an ESOP Loan constitute earnings and can be allocated in any manner the sponsor sees fit (perhaps subject to 401(a)4)).  Inasmuch as dividends also represent earnings, it seems the same rationale would apply.   While it sounds nice, I can't locate any helpful guidance or instance in which the IRS has audited such an ESOP and acquiesced on the allocation method.

Thanks again.

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I agree with TPSreports regarding the question raised by ESOP Guy about different dividend rights: The ESOP is the shareholder, not the individual participants. I think the Plan document can spell out how to allocate dividends and, similarly, S corp distributions.

On that last point, we have a unique situation where the S corp is required under shareholder agreements to distribute earnings. S corp earnings distribution to ESOP is significant. The Company does not, therefore, make an ESOP contribution. If it did, benefit levels in the ESOP would be unsustainable. The Plan document provides that distribution of S corp earnings are allocated in proportion to compensation.

I appreciate that this allocation formula is not "standard", but I can't come up with a reason why it is not okay to do this.

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I have seen non-standard things done with dividends on allocated shares - an agreed up rate of return and anything in excess of that allocated based upon compensation, for example.  Just controlled by the plan document.  Since both Titles I and II of ERISA rely heavily on the written plan terms to the extent not inconsistent with the law, I am not sure that you will find anything that says you can't do this.  Note, I am agreeing with the prior commentators that the single class of stock concept is measured at the ESOP level.  How the ESOP spreads that dividend among the beneficiaries of the trust is a function of its governing instruments.

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