ESOP Dividends - Who Gets the Deduction?

[Guest rocnrols2]

Company X has several thousand employees. X Holdings is a holding company which has publicly traded stock. Company X sponsors an ESOP with X Holdings stock. If dividends are declared on X Holdings' stock and distributed in cash to participants or, at the participant's election, are either distributed in cash or reinvested in the stock, who gets the tax deduction, X Holdings or Company X?

Code Section 404(k) provides that the deduction is available to the corporation paying the dividends. Since X Holdings has no employees, does X Holdings merely make a capital contribution to Company X and loses the deduction?

[RLL]

rocnrols2 -

Is Company X a wholly-owned subsidiary of X Holdings that uses its parent company's stock in its ESOP? Do X Holdings and Company X file a consolidated income tax return?

[Guest rocnrols2]

Yes to both questions.

[Guest Harry O]

The language of section 404(k) seems pretty clear that the dividend payor gets the deduction. In your case, that means the publicly-traded holding company would deduct the dividends. Normally you would get into a capital contribution to sub, deemed contribution by sub to plan, deduction to sub analysis under section 404. But that doesn't seem to be required here, probably because the deduction is for cash dividends paid on the holding company's stock rather than for services rendered by employees of the sub.

[RLL]

rocnrols2 -

The deduction under IRC section 404(k) is allowed on the X Holdings consolidated income tax return.

[Guest Harry O]

Even though it is allowed on the consolidated group's tax return, it is still necessary to determine which entity takes the deduction. This is because the first step in completing a consolidated return is to have each member of the group complete its own separate return first. The tax treatment of certain items may be impacted by how they are first handled on the separate returns.

[RLL]

The deduction under 404(k) is attributable to X Holdings, the parent corporation and payor of the dividends.