On March 29, the House passed the SECURE 2.0 Act (H.R. 2954) by a vote of 414-5. The bill will now go to the Senate. The bill makes two minor improvements for ESOPs plus a number of other changes aimed at making it easier for employers and employees to assure retirement plans work more effectively. Some of these will affect ESOPs.

Small Tax Deferral for Sale of Stock to an ESOP in an S Corporations Added

Under Section 1042 of the Internal Revenue Code, an owner of stock in a non-publicly traded C corporation who sells to an ESOP that owns 30% or more of the stock after the sale can defer capital gains tax by reinvesting in stocks and bonds of U.S. operating companies. For many years, advocates have urged Congress to extend this to owners of S corporations. The new bill would allow these sellers the same benefit but with a 10% limit on the deferral. So if an owner has $3 million in gain, $300,000 could be deferred. The change will not be effective until after December 31, 2027.

While this is a very small win for ESOPs, having this in the law may make it easier for a future tax bill to expand this percentage.

Change in Definition of Public Company for ESOP Valuation Purposes

ESOP companies listed on stock exchanges do not have to have an annual valuation. There has always been some ambiguity about companies that trade over-the-counter. Section 118 of the bill allows certain non-exchange traded securities to qualify as publicly traded employer securities “so long as the security is subject to priced quotations by at least four dealers on an SEC-regulated interdealer quotation system; is not a penny stock and is not issued by a shell company; and has a public float of at least 10 percent of outstanding shares. For securities issued by domestic corporations, the issuer must publish annual audited financial statements.” The new rule is effective for plan years beginning after December 31, 2026.

Very few ESOP companies fall into this category, but some community banks will likely find this new change helpful. ESOPs are common in these companies, and many have shares traded over-the-counter.

Other Changes

The bill makes a number of changes in retirement plan rules, some of which will affect ESOP companies, especially if they have a 401(k) plan. The Senate has its own version of the bill currently in process. The ESOP changes are not currently in that bill but have a good chance of being incorporated into the final law. A detailed summary of the bill was provided by the Committee on Ways and Means, and the full text of H.R. 2954 is here.