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allocations for 415 purposes on leveraged S-corp ESOP


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I'm looking at an S-corp ESOP and a 401(k) - two separate plans, handled by two separate TPA's. The ESOP TPA is saying that there's a 415 violation, and refunds of "X" must be made.

I think it is partially true, but I want to make sure I'm not all wet. The allocations under the ESOP, for 415 purposes, are showing as (pick a number - say $800,000) but the repayment of principal and interest on the loan, which is the total contribution, is, say, $700,000. As I read 1.415(c)-1(f)(2), for 415 purposes only, the allocations under the ESOP should be based on the $700,000, not the $800,000. This would reduce, but not eliminate, the 415 violations.

As an aside, share prices are higher than before, so can't use the special exception for using devalued shares.

Am I missing anything on this?

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The reason for this is becasue of this:

(ii)Employee stock ownership plans to which the special exclusion applies. An employee stock ownership plan meets the requirements of this paragraph (f)(3)(ii) for a limitation year if no more than one-third of the employer contributions for the limitation year that are deductible under section 404(a)(9) are allocated to highly compensated employees (within the meaning of section 414(q)).

 

If you look at 401(a)(9) it excludes S Corp ESOPs

(9) Certain contributions to employee stock ownership plans

(A) Principal payments

Notwithstanding the provisions of paragraphs (3) and (7), if contributions are paid into a trust which forms a part of an employee stock ownership plan (as described in section 4975(e)(7)), and such contributions are, on or before the time prescribed in paragraph (6), applied by the plan to the repayment of the principal of a loan incurred for the purpose of acquiring qualifying employer securities (as described in section 4975(e)(8)), such contributions shall be deductible under this paragraph for the taxable year determined under paragraph (6). The amount deductible under this paragraph shall not, however, exceed 25 percent of the compensation otherwise paid or accrued during the taxable year to the employees under such employee stock ownership plan. Any amount paid into such trust in any taxable year in excess of the amount deductible under this paragraph shall be deductible in the succeeding taxable years in order of time to the extent of the difference between the amount paid and deductible in each such succeeding year and the maximum amount deductible for such year under the preceding sentence.

(B) Interest payment

Notwithstanding the provisions of paragraphs (3) and (7), if contributions are made to an employee stock ownership plan (described in subparagraph (A)) and such contributions are applied by the plan to the repayment of interest on a loan incurred for the purpose of acquiring qualifying employer securities (as described in subparagraph (A)), such contributions shall be deductible for the taxable year with respect to which such contributions are made as determined under paragraph (6).

(C) S corporations

This paragraph shall not apply to an S corporation.

 

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ESOP - I think you are talking about the special treatment under f(3), and I'm talking about f(2)? So let's say the fully deductible payments of interest and principal is 700,000. This is the level annual payment that was established when the ESOP was started. But due to stock price appreciation, the shares released have a value of 800,000. For 415 purposes only, as I read the regulation I referenced in the original post, 700,000 is the amount that is allocated amongst the participants, not the 800,000 actual value of the stock.

Agree/disagree?Aare you saying that f(2) doesn't apply to an S-corporation ESOP?

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I did misunderstand the question.  I agree with you.  You don't have to use the FMV of the share released if they are higher than the cash contributions for the loan payment as Annual Additions. 

 

In your example the $700k is the Annual Additions. 

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