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Summary of Recent Legislative and Judicial Developments Involving ESOPs


September 9, 2009

Read Time

4 minutes


Much like the classic "Spaghetti Western" classic film "The Good, the Bad and the Ugly", Employee Stock Ownership Plans (ESOPs) have supporters as well as their critics. This is evident by some recently legislative and judicial developments involving ESOPs over the past several months.

The Good

On August 6, Senator Blanche Lincoln, a pro-ESOP Democratic Senator from Arkansas, introduced Senate Bill S 1612 which was entitled the "Employee Stock Ownership Plan Promotion and Improvement Act of 2009." The bill is co-sponsored by Senator Mary Landrieu (D-LA), who is Chair of the Senate Committee on Small Business and Entrepreneurship.

The bill would eliminate certain key differences between ESOPs sponsored by C corporations and ESOPs sponsored by S corporations. In particular, the bill proposes to repeal the 10% early distribution tax which currently applies if S corporation "dividends" paid on shares of stock held by an S corporation ESOP are distributed to the ESOP participants who are under age 59-1/2 (the tax arises because, unlike for C corporation ESOPs, these payments are considered early distributions from the plan). In addition, the bill would permit a shareholder who sells stock to an ESOP sponsored by an S corporation to use the tax deferred rollover of the capital gain arising as a result of the sale. This benefit is currently only available when stock of a C corporation is sold to an ESOP.

The bill would also:

  • Clarify that dividends paid by C corporations on ESOP stock are not a preference item in calculating the corporate alternative minimum tax.
  • Permit proceeds received by a shareholder who sells stock to the ESOP in a transaction where the capital gains from such sale are "deferred" to be invested in mutual funds which invest in U.S. operating corporations (currently mutual funds are not permitted investments for the capital gain deferral to apply).
  • Clarify that a small business certified by the Small Business Administration for SBA loans and programs will still be eligible for SBA status, even if 50% or more is owned by an ESOP.
  • Exempt dividends paid by C corporations on ESOP stock would no longer be a preference item for Alternative Minimum Tax calculations.

Although this bill is not likely to be enacted into law during the current legislative session, it is encouraging to know that there continue to be ESOP supporters in Congress that will continue to advocate for positive changes in the law to expand the use of ESOPs.

The Bad

According to the National Center for Employee Ownership (NCEO), the Congressional Budget Office (CBO), in its annual report on budget options, lists eliminating special ESOP tax benefits as a way to save tax dollars. The CBO report specifically referenced certain particular benefits associated with ESOPs (capital gain deferral on the sale of stock to an ESOP and the right of C corporations to take a tax deduction for dividends paid on shares of stock held by an ESOP) that might be eliminated in any tax reform proposals that might get approved by Congress in the near future. However, the report also warned that all special benefits associated with ESOPs could be removed from the tax code such that ESOPs would only have the same tax treatment as other benefit plans. The CBO report indicated that the CBO estimated that these proposals to change the tax treatment of ESOPs would save $600 million in 2010, gradually growing to $1.3 billion by 2014.

While tax reform seems to have taken a back seat to reforming our health care system, it is likely that Congress will return its attention to general tax reform issues once the health care debate is resolved.

The Ugly

In two recent cases from California, the court determined that standard indemnification agreements between the company sponsoring an ESOP and the ESOP trustee were not enforceable under ERISA. These recent court decisions are certain to have a chilling effect on new ESOP transactions. As a result of these decisions, it will be less likely that ESOP fiduciaries will want to take on an assignment to serve as a trustee of an ESOP when their right to receive indemnification is in question. Alternatively, professional ESOP fiduciaries might begin to insist that additional insurance be purchased to cover their defense costs in the event that litigation arises in connection with an ESOP transaction which will add another layer of expenses to complete an ESOP transaction in addition to the professional fees already associated with most ESOP transactions.

The attorneys in Levenfeld Pearlstein's ESOP Services Group will continue to monitor these legislative and judicial developments and provide additional information on these topics when they become available.

Filed under: Corporate

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