S-corp distribution dividend payment

[Belgarath]

S-corp is paying a dividend payment to the ESOP. As I understand it, this can be used towards the repayment of the exempt loan. According to IRC 4975(f)(7), this isn't a prohibited transaction.

Agree? If so, another question - for tax purposes, they S-corp is apparently considering this dividend as 2018. But, it is being contributed to the ESOP within a few days. Is this considered an ESOP contribution for 2018, or 2019, or can they choose either?

Thanks!

[ESOP Guy]

The first question is easy and it is a "yes" and the document will tell you how to allocate it.  It is most likely comp over comp but it doesn't have to be allocated that way.   So check the document for the how to allocate.  There can even be a difference between the allocated and unallocated share "dividend" in the document.  I have even seen some pretty odd allocations where you allocate shares equal to the dividend dollar value on comp over comp and any share value in excess of the dividend dollar value as an earnings allocation.  That is just a pain.  

I know everyone I know likes it deposited in the year it is for.  I don't know if there is a good reason or it is just cleaner.  I am not sure I am confident enough to give an answer off the top of my head as it has been many years since I have seen a dividend declared in year x and paid a few days into x+1 used for a loan payment. 

[A Shot in the Dark]

B:  ESOP Guy has all of the correct answers.

Regarding your last sentence in the 2nd paragraph, a dividend payment is not considered an ESOP contribution for 404 or 415 limits. Perhaps you meant ESOP deposit and not contribution.

Unless there is some sort of provisions set for specific timing of dividends in the corporate bylaws, "S" Dividends or "S" distributions are declared for a given year but can be deposited to the ESOP prior to the filing date of the corporate tax return showing the declared dividend.  This is true unless the Dividend or distribution is to be issued in cash to the Plan Participants, then the dividend has to be paid not later than 90 days after the end of the year in which the dividend is declared. 

[Belgarath]

Thanks. Shot - I'm not entirely sure what I meant, as the question posed to me wasn't all that specific. So if we term it a "deposit" which is then used to all or a portion of the exempt loan payment that is due in 2019, this is then NOT a "contribution" for 415 or 404 purposes, and therefore a "normal" contribution/deduction could still be made?

Maybe I'm completely mixing things up, for which a apologize in advance!

[A Shot in the Dark]

B:  You are correct. Dividends declared for payment to an ESOP are not counted as Employer contributions (although they may be allocated in the same manner).  Many times you may not even know that a dividend will need to be declared for a given year.

On behalf of an employer, using their census data received, you will compute the maximum 404 contribution, making sure allocation of said contribution does not create a 415 limit issue.  Then you will determine the necessary cash required for ESOP loan payments, participant distribution payments made for the given year and maybe even diversification payments.

Compare the two calculations and perhaps a dividend may need to be declared in addition to the employer contribution to fund all of the various cash outlays.  

[ESOP Guy]

Yeah, maybe I over assumed but I assumed you meant dividend in the second part of the question and not contribution.  While dividends can pay a loan it isn't a contribution for testing purposes.   This is the way to get lots of money into an ESOP.  You pay dividends.  It can come back to bite  you.  For example the largest shareholders get most of the dividends it can cause 409(p) testing issues in a S Corp ESOP if they are using that cash to buy more and more shares.     So while Shot is correct in saying that is how you meet the cash requirements make sure the plan isn't being set up for other problems.  Large dividend payments can cause have/have not issues also.  That is the problem where the new employees have little to no stock because the long term employees are getting most of the allocations that favor dividends allocated on shares vs contributions that use comp for the allocation. 

I guess what I am saying dividends solve a number of testing problems like all of life there is good and bad with any idea. 

I guess as long as we are getting in the weeds don't forget if you use allocated dividends the FMV of the shares released have to equal the dollar value of the dividends allocated to the person.   There has to be a provision in the plan describing this requirement as it is a legal requirement. 

And if you really want to get into the legal weeds S Corps don't legally speaking pay dividends.  They pay S Corp earnings distributions (I think that is the legal term).   And there are some rule differences.  For example you can't pass through S Corp "dividends" like C Corp dividends. 

In fact I know some lawyers that would object to using S Corp dividends for loan payments as some of those rules seem to be in the part of the IRC that applies only to C Corp dividends.   They are a minority.  

[Kevin C]

If there is more than one tranche of stock, you will also want to keep in mind that you can only use dividends / S-Corp distributions attributable to the stock purchased with an exempt loan towards the loan payments on that loan.  I've seen the cite listed as 54.4795-7(b)(5).  Here is a National Center for Employee Ownership article on the subject.

https://www.nceo.org/esop-operational-issues/c/esop-debt-payments-dividends-distributions

[Belgarath]

Thanks Kevin.