Leveraged ESOP establishes loan on last day of plan year

[Guest pensionadmin]

ESOP buys company shares & takes out loan on the last day of the plan year (12/31/01). Loan principal & interest payments begin as of 2/1/02. Per research I've done, they can deduct up to 25% of covered payroll even though payments aren't made until the extended due date of their tax return (9/15/02) provided contributions are allocated as of 12/31/01 & 2001 compensation is used as the basis for making the allocations.

My question is do I just allocate cash as of 12/31/01? Or would I calculate shares released by the subsequent payments on the loan made through 9/15/02 and allocate those shares (this option doesn't make sense to me?).

Has anyone else had this situation come up? I'd like to hear how you handled it.

[RLL]

Hi pensionadmin ---

It's better to show the allocation in shares, as the dollar amounts used for loan payments are likely to be very different from the post-transaction value of the allocable shares. Since the benefits that participants will derive from the ESOP are based on share values, it makes more sense to reflect allocations in shares to the extent possible. This may be difficult if you can't determine the number of shares that will be allocable until September but want to provide participant statements at an earlier date.

[Kirk Maldonado]

The IRS has indicated (informally, I seem to recall) that they don't like people deducting interest in a prior year (2001) that accrued in a subsequent year (2002).

[IRC401]

Book the transaction as if the money were actually deposited on 12/31.

If cash had been deposited on 12/31, it would have been allocated to the participants' accounts as cash and then used to purchase shares from the suspense account in 2002. Therefore, as of 12/31 the participants accounts' held cash.

[Guest pensionadmin]

Thank you all for your help! Both the client's attorney and accountant want me to go the cash route so that's what I'm going to do.