The Employee Ownership Update
June 21, 1999
New ESOP Legislation IntroducedDana Rohrabacher (R-CA), arguably the most conservative member of Congress, has paired with Bernie Saunders (D-VT), the only Socialist member of Congress, to introduce H.R. 1462, "The Employee Ownership Act of 1999." The bill, drafted by Rohrabacher, would provide that a company that is at least 50% owned by an employee ownership trust, allows each employee one vote on all corporate issues, and includes 90% of all full-time employees to participate in the trust would not pay any federal income tax. Moreover, employees or other current owners selling their stock back to the company would not pay tax, estates could receive a tax credit for transfers of stock to the trust, and non-trust owners would not pay tax on the first 25% of dividends they receive.
The bill has 34 cosponsors, but even its strongest advocates do not believe it will actually pass. Rohrabacher instead sees this as a means of generating discussion of how employee ownership can be made a larger part of America's economic agenda.
On a more modest note, Senators John Breaux (D-LA) and Orrin Hatch (R-UT) have introduced legislation (S. 1132) that would allow employer tax deductions on dividends paid on ESOP shares that employees choose to reinvest in employer stock. A similar bill (H.R. 2124) has been introduced in the House by Cass Ballenger (R-NC), Karen Thurman (D-FL) and others. Currently, only dividends passed through to employees or used to pay an ESOP loan are deductible. Some public companies have obtained private letter rulings for a "dividend switchback" program that, in effect, allows employees to reinvest dividends through a 401(k) program, although there are some limitations on this approach. The legislation, if passed, would not exempt the reinvestment from potential securities laws issues that could limit their appeal to private companies (although recent securities rules changes could lessen these concerns). The Ballenger bill also would permit distributions from ESOPs for education and first-time home mortgage costs without requiring a 10% penalty tax for the employee.
Bar Group Urges Different Approach on ESOP S Corporation ReformThe New York State Bar Association's Tax Section has urged the Administration to change its proposals to tax ESOPs in S corporations. While the Section agreed that the ESOP should have to pay an unrelated business income tax on its pro-rata share of S corporation earnings, it argued that if the ESOP does pay the tax, participants should get an exclusion for items of previously taxed income. It also argued that S corporation ESOPs should be subject to the same tax benefits as C corporation ESOPs.
Employees Can Sue on Options Programs Based on Sex DiscriminationA federal district court has certified a class of employees to proceed with a lawsuit contending their employer's stock option allocation policies violated Title VII of the Civil Rights Act of 1964 (Carter v. West Publishing Co., M.D. Fla., No. 97-2537-CIV-T-26A, 5/20/99). The suit claims that a discriminatory pattern of option awards left 29 female employee with "table scraps" when their legal information publishing company was sold in 1996. The plaintiffs contended that female employees were systematically excluded from or given only token option awards compared to their male counterparts.
A similar suit is now underway in California. If the plaintiffs prevail, it could cause a major reevaluation of option programs in many companies. Because option programs are discretionary by nature, however, many legal experts are doubtful that the Civil Rights Act can be used to sustain a suit over their allocation.