Will Subchapter S Reforms Really Help ESOPs?

1996 tax law changes are unlikely to create many new ESOPs in Subchapter S companies. That's the conclusion reached by Bob Stiles of Liberty Check Printers in Mounds View, MN, the first Subchapter S company to set up an ESOP after the new law was passed. The new law allows Subchapter S companies to set up ESOPs in 1998, but does not provide them with some of the special tax benefits ESOPs get in "C" corporations. These include the ability to defer taxation on gains made from the sale to ESOPs owning more than 30% of stock in a closely firm, deductibility of dividends passed through to employees, and larger contribution limits on leveraged ESOPs.

More troubling, technical problems with the law will make it unappealing to most "S" corporations. For instance, if employees leave and put their stock into an IRA, that could disqualify the "S" election because the IRA could not hold "S" shares. Similarly, when employees leave, the company could be liable for additional taxes on the distribution to participants. These and other difficulties will be discussed in detail in a paper to appear soon on this site. Stiles is helping establish a lobbying effort to change the law to make it more practical. He can be reached at 612-783-6300. Some members of Congress have already expressed an interest in revisiting the issue.