Corporation was 2/28 fiscal year-end for tax purposes and calendar year-end for ESOP. In 1998, elected S-Corp status. The S-Corp filed a short year (3/1-12/31) tax return for 1998. Does this have any effect on the ESOP regarding their deductibility limits? Do we use 3/1-12/31 wages or 1/1-12/31 wages for the ESOP?

The deduction limits under Section 404(a)(3)(A) of the Code are based on compensation otherwise paid or accrued by the employer during the taxable year to employees who are beneficiaries under the plan. Since the taxable year is the short year (3/1 - 12/31) the deduction limit for that short tax year is based on compensation paid during that short year. Note that because the ESOP is maintained by an S corporation, the increased deduction limit under Section 404(a)(9) of the Code is not available. Accordingly, the deduction limit is 15% of compensation, unless the ESOP includes a money purchase pension feature or the S corporation has pre-1987 credit carryovers.

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