leveraged ESOP - loan payments and deductibility

[Tom Poje]

now what?

using nice rounded numbers,

required loan payments = $750,000 300,000 is principal, 450,000 is interest.

25% of eligible comp = 150,000

plan prohibits making a contribution greater than the deductibility.

so, do the loan payments release shares that are simply held in 'limbo'?

and then this is carriedforward, along with penalty for nondeductibility?

yes, this looks like some 'poor planning' on someone's part because the future will have the same problem.

[Guest Doug Johnston]

If the Company is a C corporation, there is no limit on the deduction for interest under section 404(a)(9), right?

Can the shortfall be made up with dividends (or "distributions" if the Company is an S Corporation?)

You should be able to allocate all the released shares, whether from contributions or dividends/distributions, subject to the 415 limit.

[Tom Poje]

I am not worried about the interest, I know that is not a problem.

the issue is that 300,000 is paid on the principal, but the 25% of comp deductibility is only 150,000.

so does that simply create a large nondeductible contribution (along with penalties) or is it a situation that because the loan requires the payment (mandatory, so employer has to make the contribution) there is a way out in a leveraged ESOP.

[BeckyMiller]

I am not aware of any way out of the penalty assuming the year has closed and the contribution was already made.

There are, however, several letter rulings which have allowed a company to refinance an ESOP loan where the principal amortization cannot be accomplished within the 404 or 415 limits. As I recall, they all relate to changes in the business, rather than poor front-end planning.

Advice - get good ESOP/ERISA counsel and figure out how to refinance the loan, expand eligibility to increase comp. base and/or recapitalize to create a dividend paying stock for the ESOP....

Good luck!

[Tom Poje]

fortunately, at least from grief at this end, I only need to 'run the val on the system' - I dont need to contact the company involved directly.

the document is specific in that the contribution can not exceed the max deductible under 404(a).

any contribution which are not deductible shall be returned to the employer.

the typical language. but this of course is for a loan repayment which has to be made. it is just not all deductible.

so I guess the question is what is done.

it sounds like the allocation or release of shares is whatever is deductible.

but then what? the loan is reduced by the amount that was paid, shares are released but not allocated to anyone?

[BeckyMiller]

Tom - Can I assume that the contribution was made during the plan year?

It is an interesting quandry - the plan probably requires contributions in sufficient amounts to meet the debt service and also calls for no contributions in excess of what is deductible. So, conflicting terms.

If the conclusion is that the funds have to stay in the plan, I believe that you will need to allocate them to that year's participants. With the current state of the 415 limits, it is pretty unlikely that you will have any 415 suspense, but you may for the folks who hit the dollar limit. That depends upon the 415 language.

I have never seen plan language that would allow a nondeductible amount to remain unallocated. Nor, am I familiar with any allowable suspense accounts other than a 415 suspense and the ESOP collateral suspense.

But, I would like to hear from others. Where is RL, when you need him?