On The Legislative Front:
New Bills Would Enhance ESOP Benefits

US Capitol

If favorable legislation is any indication of the popularity of a concept in Congress, it’s been a long time since employee stock ownership plans (ESOPs) have found so much favor. Within the last few months several pieces of legislation have been introduced that focus not only on preserving ESOP benefits, but improving them.

In the Senate - The largest new piece of legislation regarding ESOPs is Senate Bill 1612 (S. 1612) known as the ESOP Promotion and Improvement Act of 2009, which was introduced by Senator Blanche Lincoln (D-AR). The bill is crafted to make four significant changes in ESOP-related law that would, presumably, make ESOPs even more attractive than they are now by:

  • Amending the "premature distribution penalty tax" that applies to distributions from qualified retirement plans to exclude distributions or S corporation earnings that pass through an ESOP to participants. Those "pass-through distributions" are currently treated as in-service distributions subject to all the taxes applicable (including the 10 percent premature distribution penalty when the recipient is not at least 59.5 years old, or over retirement age as defined in the plan).
  • Removing deductible dividends paid by a C corporation ESOP company from the list of preference items that are added back to taxable earnings in determining corporate alternative minimum tax.
  • Amending IRC Section 1042 to (1) give sales of stock to S corporation ESOPs the right to elect the same reinvestment, rollover and deferral of tax treatment that is now only available to C corporations; (2) expand the definition of qualified replacement property (QRP) to include mutual funds comprising stocks that would individually qualify as QRP; and (3) revise the 25 percent shareholder exclusion from allocations to include only shareholders who actually hold 25 percent or more of the company (as opposed to holders of 25 percent of any class of stock as it is currently written).
  • Amending the Small Business Administration preference criteria to include any majority ESOP company (50 percent or more owned by an ESOP) that qualified for a preference prior to the ESOP adoption, provided the relevant characteristics of the company have not changed.

This bill, which currently has seven co-sponsors in addition to Senator Lincoln, is in the Senate Finance Committee for review and consideration.

In the House of Representatives: Representative Ron Kind (D-WI) subsequently introduced a bill with some similar characteristics. As in S. 1612, H.R. 3586, titled the S Corporation ESOP Promotion and Expansion Act of 2009, includes a provision that would extend the rollover and deferral election to sales of stock to S corporation ESOPs on the same terms as available to sales of stock to C corporation ESOPs. This bill goes further, however, to resurrect a couple of significant benefits that have either been repealed or expired many years ago. These provisions propose adding tax benefits for S corporation ESOPs including:

  • Allowing a lender to an S corporation ESOP to exclude from income 50 percent of the interest earned on the loan, provided the loan is for the purpose of funding a stock acquisition. This parallels the provisions of IRC Section 133, which was modified and then allowed to expire in the 80s.
  • Allowing an ESOP to assume liability of an estate if stock of the decedent's S corporation of value equal to the tax is transferred to the ESOP. This would allow the ESOP to take over the installment payment option related to taxes due on account to the decedent's estate, and effectively get a low-interest loan from the government for the purchase of shares for the plan. This is reminiscent of another IRC section that came and went in the 80s.
  • Establishing a federal program within the Department of Labor to encourage creation of S corporation ESOPs.

This bill also has seven co-sponsors and has been referred to both the House Committee on Ways and Means as well as to the Committee on Education and Labor with regard to the provisions under each committee's jurisdiction.

Nearly a year ago, in January 2009, longtime friend of employee ownership Dana Rohrabacher (R-CA-46) introduced a very ambitious bill titled H.R. 692: To amend the internal revenue code of 1986 to exclude from gross income compensation received by employees consisting of qualified distributions of employer stock. The bill is intended to encourage ESOPs as a way of providing stock ownership for employees of public companies, since under this provision, the value of stock awarded directly to employees would be excluded from income if the stock is held by them for 10 or more years.

Most recently, on October 22, 2009, a House Resolution (H. Con. Res. 204: Expressing continued support for employee stock ownership plans) was introduced stating renewed commitment to the expansion of employee ownership as a priority for Congress. This resolution introduced by Congressperson Maurice Hinchey (D-NY-22) has no legal substance other than as an expression of congressional intent, but would be a very clear statement of support.

Finally, we understand that a House bill identical to S. 1612 is also being drafted for introduction before the close of this session. This strategy of creating a "companion bill" to proceed simultaneously through the other chamber is intended to increase its likelihood of passage.

Whether any of these bills will be passed in Congress this year remains to be seen, but it is clear that there are a growing number of friends of the ESOP concept currently seated in government. If you are interested in any or all of these bills, we suggest that you contact The ESOP Association for information on sponsors and influential committee members who would appreciate your input.

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