Tax Deductions for Leveraged ESOPs

[Guest tfurlong]

Is the employer contribution to the plan 100% deductible in a leveraged ESOP? I have been told that only the principal portion of the loan repayment is tax deductible as a contribution while the interest portion is excluded. The reason is that the interest expense incurred on the external bank note is already fully deducted. Any help would be appreciated. --Tom

[RLL]

Hi tfurlong ---

IRC section 404(a)(9) allows contributions that are used for ESOP loan principal payments to be deductible in amounts up to 25% of covered payroll; and also allows for contributions that are used for ESOP loan interest payments to be deductible without a specific limit.

In the case of a typical "back-to-back" ESOP loan arrangement, the loan to which section 404(a)(9) refers is the sponsoring company's (internal) loan to the ESOP....there is no deduction thereunder that relates to the company's "external" bank loan (except to the extent that the two loans might be "matched"). The company's contributions that are used by the ESOP to pay loan interest (to the company) are deductible, but such deductions are "offset" by the interest income received by the company.

Note that section 404(a)(9) is not available to S corporations.