November 20, 2006
What will the new Democrat-controlled Congress mean for the future of ESOPs? Optimists would argue that ESOPs have always been bipartisan. Senator Russell Long, Democrat of Louisiana, was the legislative father of the ESOP, and the sponsor of the current pro-ESOP bill in the Senate is Democrat Blanch Lincoln of Arkansas. There are also several Democrat co-sponsors of the House version of the same bill, and Senator John Breaux, Democrat of Louisiana was an ESOP champion until his retirement two years ago.
Pessimists would argue that the strongest support for ESOPs in the House of Representatives for quite a few years has come from Republicans and that in the past two years we have lost several ESOP champions due to retirement or election, including Representatives Cass Ballenger and Nancy Johnson, and Senator George Allen.
In our opinion, it is too early to be optimistic or pessimistic, but it is not too early to be concerned, practical, and to take action.
Concerned
The Treasury Department is expected to make its recommendations regarding tax reform to the Congress in 2007. For over a year, they have been reviewing recommendations on tax reform made by a Presidential Commission, which recommended among other things eliminating all defined contribution retirement plans. ESOPs are a type of defined contribution plan. See “Eliminate All ESOPs?”
The incoming chairman of the House Ways and Means Committee, Charles Rangel, has stated that he will “work with the President on tax reform”. Anytime broad-base tax reform is considered, it should be a cause of concern for ESOP supporters. It should be more of a cause of concern because the Treasury Department has refused to provide ESOP advocates any comfort that their recommendations will protect ESOPs. Maybe they will or maybe they will not; we just do not know. Even if ESOPs are not a specific target for elimination, they could be caught up in the congressional need to “pay” for additional tax cuts. In order words, the House Ways and Means Committee and/or the Senate Finance Committee may decide that there needs to be a cut-back to certain ESOP benefits in order to make room for other tax incentives.
What Might Get Cut Back?
Tax-free S Corporation income could certainly become a target as it is the “new kid on the block,” becoming effective in 1998.
Practical Considerations
If you are concerned, and you should be, what can you do? If you are considering implementing an ESOP, or if you have an existing ESOP that contemplates acquiring additional stock, take a close, hard look at doing it very soon. The effective date of a tax bill, assuming it passes both the House and Senate and is signed by the President, is frequently the day it is reported out of the House Ways and Means Committee. In theory, this could occur anytime after Congress convenes in January 2007. Practically speaking, March would seem to be the earliest possible date.
Will ESOP Provisions Be Grand fathered?
Over the past thirty-two years, ESOP tax benefits have been reduced or eliminated on several occasions, and in those instances what was in place was grand fathered. While this history of grand fathered ESOP tax benefits is no guarantee, we believe there is a high probability that any existing ESOP structure would be grand fathered. For example, if the ESOP S Corporation tax-free benefit was eliminated or reduced, the percentage of stock owned by the ESOP prior to the effective date of the new legislation would continue to be free from federal income tax under a grandfather provision.
Action Required
For those companies contemplating an ESOP transaction, whether it be a new ESOP or an increase of ownership in an existing ESOP, the time to study the matter very carefully is now.
by Ronald J. Gilbert, ESOP Services, Inc.