Administration, Congress Moving Closer on ESOP S Corporation Reform

The Clinton Administration has proposed a new version of its ESOP S corporation reform legislation that would require ESOPs in these companies to pay unrelated business income tax (UBIT) on its pro-rata share of corporate profits if more than 10% of the allocations in the plan went either to highly compensated employees (as defined by the law) or 2% shareholders. UBIT would also be required if more than 10% of the ownership in the company is represented by synthetic equity (options, phantom stock, etc.). "Highly compensated" means an employee who (a) was a 5% or more owner at any time during the year or the preceding year; or (b) had compensation in excess of $80,000 (indexed to 1997 dollars) in the preceding year or, if the employer elects, was in the top 20% of employees ranked on the basis of compensation. The Administration's proposal would thus cover many existing S corporation ESOPs.

At Congressional hearings, however, the Administration said that it was willing to work with Congress this issue. The current Congressional sentiment is for a much less restrictive rule, but also one that aims to curb S corporation ESOPs that are not primarily benefiting everyday employees. This suggests that some compromise may be forthcoming.