Senate Passes ESOP S Corporation Reform Rules, But Measure Dropped in Final Tax Bill

As part of a bill extending expiring tax incentives (S. 1792), the Senate adopted legislation introduced by Congressman James Ramstad (R-MN) and Senator Donald Breaux (D-AL) (HR 3082 and S 1732) designed to curb abuses of the S corporation ESOP law. The proposal builds on a similar bill that was in the tax bill President Clinton vetoed. It defines as a disqualified person anyone who has more than 10% of the deemed fully allocated shares of the company, or whose family has more than 20%. If this group owns 50% or more of the company, including through synthetic equity, then no one in the group can get an allocation of shares in the ESOP that year. Violations trigger a 50% corporate excise tax and individual income tax. If these anti-allocation rules are triggered, there would also be a 50% excise tax on the company on any "synthetic" equity that this group holds that year.

The House Ways and Means Committee appeared favorably disposed towards the bill, but the Administration opposed any change to S Corporation ESOP rules that did not eliminate the non-taxability of the ESOP trust in these companies. In the rush to adjourn, the House sent to the Senate a tax extenders bill that continued only those tax incentives that the House, Senate, and Administration agreed on. The ESOP provision, therefore, was not included. The bill's sponsors will try again next year on another vehicle.