Allocate k-1 income of S-corp to ESOP?

[John A]

A C-corporation with an existing ESOP plan became an S-corp for the 1998 calendar plan year. The S-corp has Schedule k-1 income. Does the income need to be allocated to the ESOP plan as a shareholder? If the income is allocated in the ESOP, on what basis is it allocated? Is it allocated on ending shares? Is it deposited in the cash account? In this case, the company is not wholly owned by the ESOP.

[RLL]

The ESOP's proportionate share of the S corporation income is "allocable" to the ESOP under Subchapter S of the IRC, but the ESOP is exempt from tax on such income per IRC Sec. 512(e)(3).

There is nothing to allocate to ESOP participants' accounts except to the extent that the S corp pays a distribution (dividend) to its shareholders. In that case, the "dividend" is allocated among participants' accounts as provided in the plan document.....if shares are allocated, the dividend generally would "follow" the shares.

The cash received as a dividend may generally be used in the same manner as other cash received by the ESOP......buy more shares of employer stock, pay benefit distributions, accumulate in "other investments," etc., as provided in the plan document. If there is an outstanding ESOP loan, dividends on "suspense account" shares may be applied to loan payments (assuming the plan documents and loan documents so provide), but it is the position of IRS that dividends on S corp stock allocated to participants' accounts may not be used for loan payments.

[John A]

Thanks, RLL, for an extremely helpful answer. It is much appreciated!

[John A]

Thanks, RLL, for an extremely helpful answer. It is much appreciated!