allocations for 415 purposes on leveraged S-corp ESOP

I'm looking at an S-corp ESOP and a 401(k) - two separate plans, handled by two separate TPA's. The ESOP TPA is saying that there's a 415 violation, and refunds of "X" must be made.

I think it is partially true, but I want to make sure I'm not all wet. The allocations under the ESOP, for 415 purposes, are showing as (pick a number - say $800,000) but the repayment of principal and interest on the loan, which is the total contribution, is, say, $700,000. As I read 1.415(c)-1(f)(2), for 415 purposes only, the allocations under the ESOP should be based on the $700,000, not the $800,000. This would reduce, but not eliminate, the 415 violations.

As an aside, share prices are higher than before, so can't use the special exception for using devalued shares.

Am I missing anything on this?

You are confusing the C Corp rules with the S Corp rules. 

A C Corp can ignore interest payments an S Corp can NOT ignore interest. 

The reason for this is becasue of this:

(ii)Employee stock ownership plans to which the special exclusion applies. An employee stock ownership plan meets the requirements of this paragraph (f)(3)(ii) for a limitation year if no more than one-third of the employer contributions for the limitation year that are deductible under section 404(a)(9) are allocated to highly compensated employees (within the meaning of section 414(q)).

If you look at 401(a)(9) it excludes S Corp ESOPs

(9) Certain contributions to employee stock ownership plans

Or am I not understanding your question?  What is the $700k vs the $800k?  What is the $100k?  I guess that might not be clear.  I was thinking it was the difference between principal and total payment. 

ESOP - I think you are talking about the special treatment under f(3), and I'm talking about f(2)? So let's say the fully deductible payments of interest and principal is 700,000. This is the level annual payment that was established when the ESOP was started. But due to stock price appreciation, the shares released have a value of 800,000. For 415 purposes only, as I read the regulation I referenced in the original post, 700,000 is the amount that is allocated amongst the participants, not the 800,000 actual value of the stock.

Agree/disagree?Aare you saying that f(2) doesn't apply to an S-corporation ESOP?

I did misunderstand the question.  I agree with you.  You don't have to use the FMV of the share released if they are higher than the cash contributions for the loan payment as Annual Additions. 

In your example the $700k is the Annual Additions. 

Muchas gracias!