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The Employee Ownership Update

Corey Rosen

May 28, 1997

(Corey Rosen)

ESOP S Corporation Legislation Introduced

Legislation that would treat Subchapter S corporation ESOPs the same as C corporation ESOPs has been introduced in the House and the Senate. Both bills would also add other incentives to ESOPs.

S. 673 was introduced by Senators John Breaux (D-La) and Orrin Hatch (R-UT), both on the Senate Finance Committee. It would provide S corporation ESOPs with the same tax benefits available to C ESOPs, would allow S companies to require employees to take cash for their stock when they leave, and would repeal the "unrelated business income tax" provision that would have resulted in effective double taxation in many S corporation ESOPs. Bob Stiles of Liberty Check Printers, who has been leading the effort to reform the "Sub S" law, told the NCEO the legislation is exactly what his coalition hoped it would be. Parallel legislation (H.R. 1592) has been introduced in the House by Cass Ballenger (R-NC), Sander Levin (D-MI), and others.

Both bills would also provide section 1042 capital gains tax deferral treatment to employees who acquire shares through stock options. These employees currently cannot qualify for the provision. Companies could not deduct the spread on options sold to an ESOP, however. The bills also would clarify that employees can use dividends paid on ESOP shares to reinvest in 401(k) plans (the IRS has allowed this in private letter rulings, but required a complex procedure to qualify). Finally, the bills state that to be excluded from ESOP allocations in stock subject to the 1042 rollover, employees would have to own 25% of the total value of company stock, or 25% of the voting stock, not the current law's provision of 25% of any class of stock.

H.R. 1592 has additional provisions allowing an ESOP to assume an estate's tax obligation in return for an equivalent amount of stock. This little-used provision was in effect between 1984 and 1989, when it was repealed. It also would allow gifts of stock to an ESOP to be treated as charitable contributions.

The bipartisan support of the bills gives supporters hope that at least the Subchapter S changes can pass as part of this year's tax bill; the other provisions are less certain.

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