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The Employee Ownership Update

Corey Rosen

November 22, 1995

(Corey Rosen)

Department of Defense Proposes Regulations Unfavorable to ESOPs

The Department of Defense has issued proposed regulations on reimbursement for ESOP defense contractors that could discourage ESOP formation in this industry. The proposed regulations are intended to deny any cost reimbursement to ESOP sponsors beyond what they would get if they sponsored other kinds of retirement plans. Interest payments on an ESOP loan and payments for principal in excess of 15% of pay would no longer be reimbursable. The cost of employer contributions would be the post-transaction valuation, not the acquisition cost, driving reimbursements down where there is an ESOP loan. DOD auditors would also be given a much larger say in approving valuation. There could also be limits of reimbursements for reallocated forfeitures. The proposed regulations do not change the tax status of ESOPs, only the amount the government will consider an allowable cost for reimbursement.

The DOD currently does not allow interest expenses in general to be reimbursed, so there is a stronger argument for this than for other changes. Some defense contractors had used the provision to allow their ESOP to acquire other firms and be reimbursed by the government, leading to complaints from competitors. The other elements in the proposal seem to indicate less understanding of how ESOPs work.

For a copy of the proposal (60 FR 56216) contact Jeremy Olson at 202-501-3221. Comments can be submitted by January 8, 1996, to the FAR Secretariat (VRS), 18th & F Streets NW, Rm. 4037, Washington, DC 20404. Copies of comments can be copied to Congressional representatives.

Budget Reconciliation Bill Passed; Section 133 Dropped

As reported earlier, the Senate eliminated section 133 of the Internal Revenue Code. Section 133 allows lenders to ESOPs that own more than 50% of a company's shares and pass through full voting rights to exclude 50% of the interest income on ESOP loans from taxable earnings. The House did not have a comparable provision in its budget reconciliation bill, but House conferees have accepted the Senate proposal. The bill will now be vetoed by the President. If an agreement can be reached on the many issues in the budget bill, it is likely that section 133 will be eliminated. The Administration appears unlikely to take a strong position one way or another on the issue.

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