Senate Republicans Want to Eliminate ESOP Loan Benefit

Senate Finance Committee Republicans have agreed on a proposal to eliminate Section 133 of the Internal Revenue Code. The section provides lenders with a 50% interest income exclusion for loans made to ESOPs that (1) own at least 50% of the company and (2) pass through full voting rights to participants on shares acquired by the loan that are allocated to employee accounts. According to the Republican staff, the move would save $1 billion over seven years.

Section 133 was originally available for any ESOP loan, but it was changed in 1989 to its current, more restricted, form after over $20 billion was borrowed though ESOPs during a 12-month period between mid-1988 and mid-1989. Most was borrowed by large public firms, some of which used the ESOP as a takeover defense. The provision results in loan rates about 10% below what they would otherwise be for ESOP firms because lenders typically pass on some of the benefit to borrowers. In the current interest rate environment, that is not a "deal maker," but it does provide an extra margin of error in large ESOP transactions.

As this was written, it was not clear if the provision would apply to all current 133 loans--meaning that banks could not exclude any more interest on loans already in process--or just to new loans. The $1 billion figure, however, could not possibly apply if it only applies to new loans because relatively few (probably fewer than 30 or 40 at most) such section 133 loans are entered into each year. The committee will mark up the bill soon, probably this week, so the details will become available soon.

While the loss of the provision is itself not worrisome -- it is a relatively minor factor in ESOPs -- it could signal a willingness of the committee to attack other ESOP provisions in the future. Indeed, one Senate staffer reportedly said that this is the objective for next year. Ironically, the section 133 change would be instituted to pay for cuts in capital gains taxes.