1042 Elections and 25% owners

[Guest Scrappy]

On November 2, 2001, owners of C-Corporation owners sell 45% of stock to the ESOP. Owners make a 1042 election. On November 30, 2001, owners sell remaining 55% of stock to 2 employees. ESOP is on a calendar year.

Are these two employees prohibited from ever receiving an allocation of the "1042" stock? Even for the 2001 plan year?

[RLL]

Hi Scrappy ---

If each of the two employee shareholders continue to own more than 25% of the outstanding shares on any allocation date during the "nonallocation period" defined in IRC section 409(n)(3)©, which is at least 10 years after the sale, they are prohibited from sharing in the allocation of the 1042 shares under the ESOP. This includes the 12/31/01 allocation.

Did the two employees pay the same per share price as the ESOP paid for its stock?

[Guest Scrappy]

Yes, they paid the same amount per share. And our plan document clearly states the "nonallocation period". Thanks for the quick reply.

[Guest Scrappy]

I have another question about deductibility. One attorney told me that according to 404(a), all payments to an ESOP's leveraged loan must be within the 25% of compensation limit. Yet, I have an article stating a C-Corporation leveraged ESOP may deduct more than 25%, if the principal payments of the loan do not exceed 25% of eligible compensation as long as 1/3 of the contributions are not allocated to the HCEs.

What's correct?

Thanks.

[RLL]

Look at IRC section 404(a)(9), which allows a C corporation to deduct contributions used by the ESOP to pay loan interest without regard to the 25% of compensation limit.