An S-Corp ESOP is exchanging shares of different classes (all the features will be the same so it should be permissible)(A shares to B shares). The value of the B shares will be greater than that of the A shares. There will be a dividend paid and I wanted to know if the dividend associated with this transfer will be considered earnings. If so, I won't have any potential 415 problems. Any help would be appreciated.

S corporations are only allowed to have a single class of stock. The only exception to this is that they can have non-voting common that is otherwise identical to the voting common. The ESOP tax advantages are limited to the voting shares - i.e. qualifying employer securities. So, if your client is doing this, I can only assume that they are taking this action with respect to all shares, not just ESOP shares or they are 100 percent ESOP owned.

When you say there is a dividend being paid are we talking about cash or stock? A stock dividend is not treated as earnings, it is just treated as a fractional split. If cash and it is a dividend, it would be earnings.

I suggest that you get a better understanding of the proposal, an experienced ESOP legal advisor and an experienced S corporation tax advisor. As you have described this event, it makes my hair stand on end with the potential problems. Before your hair stands on end - these are just POTENTIAL problems.