[Congressional Record Volume 143, Number 54 (Wednesday, April 30, 1997)]
[Senate]
[Pages S3847-S3849]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BREAUX (for himself and Mr. Hatch):
  S. 673. A bill to amend the Internal Revenue Code of 1986 and 
Employee Retirement Income Security Act of 1974 in order to promote and 
improve employee stock ownership plans; to the Committee on Finance.


                     THE ESOP PROMOTION ACT OF 1997

  Mr. BREAUX. Mr. President, I rise today to introduce a measure that 
will enhance employee ownership in businesses across America. The ESOP 
Promotion Act of 1997, which I introduce today with my colleague, 
Senator Hatch of Utah, will facilitate employee ownership and 
retirement savings and enhance the opportunities for America's 
entrepreneurs to gain improved access to capital. This legislation 
would both improve and update a number of obsolete operating rules for 
employee stock ownership programs and would implement the full intent 
of Congress, which last year passed legislation designed to make ESOP's 
available to Subchapter S corporations.
  The ESOP Promotion Act benefits the owners and workers in the 2 
million S corporations which exist in every industry in every State 
across America. As the country's principal corporate vehicle for 
entrepreneurs and family business startups, S corporations have long 
been engines of economic growth. Unfortunately, the restrictions placed 
on these businesses have also resulted, more recently, in reduced 
capital access for S corporations. For an S corporation which had hit 
the limit on the number of allowable shareholders or the amount of 
personal debt that its owners could assume to keep the company in 
business, there has been a burdensome capital crunch affecting not only 
these companies directly, but hindering the ability of our entire 
national economy to realize its growth potential.
  Last year, as part of the Small Business Job Protection Act of 1997, 
Congress enabled S corporations to have

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ESOP's. I was proud to be a cosponsor of that measure, which by 
allowing S corporation ESOP's did two additional, critical things: it 
gave S corporations a new way to access funds without putting any new 
burdens on the Federal tax base, and it gave millions of workers a way 
to participate directly in the success and growth of the businesses 
which employed them.
  But despite the success we marked in 1996, the many S corporations 
which now want to build ESOP's cannot. The reason: there continues to 
be a number of largely technical hurdles in the Tax Code that make it 
difficult, if not impossible, to establish and sustain these employee 
ownership programs.
  One example of such a hurdle, is that, under current law, if an S 
corporation's ESOP distributes stock to its employee participants, and 
even one employee rolls over his stock into an entity that is not a 
permissible S corporation shareholder--say, an IRA account--then the 
company's Subchapter S election will be entirely invalidated. This, of 
course, is a risk that no S corporation is willing to take, and while 
the problem seems minor and technical on its face, no S corporation 
will establish an ESOP under these conditions.
  Another example of a technical disincentive is that, while S 
corporations were established in the 1950's as pass-through companies 
which pay a single layer of taxes, the S corporation ESOP would have to 
pay two layers of tax--one when the S corporation distributes stock to 
the ESOP, and the other when the ESOP distributes stock or cash to 
its participants. The second layer of tax was certainly not envisioned 
by Congress when we permitted S corporations to have ESOP's last year. 
Unfortunately, in its current form, this technicality means that an S 
corporation ESOP participant would pay a nearly 70 percent greater tax 
on his share of income than he would if he owned the company's stock 
directly. As such, S corporation ESOP's are not yet viable for 
employees, though we certainly intended that they would be when we 
established them.

  The legislation that we are introducing eliminates these and other 
technical problems by establishing parity between ESOP's sponsored by S 
corporations and those sponsored by C corporations; ensuring S 
corporation ESOP participants that they are subject to only one layer 
of taxation; and permitting employees to sell certain stock to an ESOP 
and defer tax on gain.
  In addition to the important S corporation measures in the 
legislation, the ESOP Promotion Act would improve the retirement 
savings opportunities for American workers. The bill would give 
employees the option to direct employers to retain dividends paid on 
employer stock in the ESOP/401(k) plan for reinvestment in the employer 
stock. Employees could then defer income taxes on the dividends and 
allow them to grow tax-free in their ESOP/401(k) plan until retirement.
  The bill would also correct an inequity to workers in the current tax 
law which provides an incentive for employers to pay the dividends to 
employees in cash, rather than to reinvest them in the ESOP/401(k) 
plan. Employers currently receive a tax deduction for dividends paid on 
stock held in the ESOP/401(k) plan only if the dividends are passed 
through to plan participants or are used to pay off an ESOP loan. The 
ESOP Promotion Act would provide employers with the tax deduction they 
currently receive on dividends paid on employer stock that is passed 
through to plan participants, if the dividends instead remain in the 
plan for reinvestment. This reinvestment opportunity for employees will 
enhance their retirement savings and facilitate employee ownership.
  Congress now has a responsibility for finishing the task we began 
last year--one that, perhaps, many of us believed we had completed--
when we agreed that S corporations should have ESOP's and enacted a law 
to that effect. Our bill completes the task by making ESOP's useful and 
desirable for the millions of workers in S corporations, while ensuring 
that they are suitable for the companies that wish to sponsor ESOP's. 
Clearly when Congress enacted the S corporation ESOP provision, we 
expected that it would be functional by its effective date, which is 
January 1, 1998. I hope that my colleagues will support our 
legislation, and ensure that our intent is fully implemented by the end 
of this year.
  Mr. President, I ask unanimous consent that the text of the bill be 
printed in the Record.
  There being no objection, the bill was ordered to be printed in the 
Record, as follows:

                                 S. 673

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``ESOP Promotion Act of 
     1997''.

     SEC. 2. PROVISIONS RELATING TO S CORPORATIONS ESTABLISHING 
                   EMPLOYEE STOCK OWNERSHIP PLANS.

       (a) Repeal of Provision Making Certain ESOP Benefits 
     Inapplicable to S Corporations.--Section 1316(d) of the Small 
     Business Job Protection Act of 1996 is repealed, and the 
     Internal Revenue Code of 1986 shall be applied and 
     administered as if the amendments made by such section had 
     not been enacted.
       (b) Repeal of Application of Unrelated Business Income 
     Tax.--Section 512(e) of the Internal Revenue Code of 1986 is 
     amended--
       (1) by striking ``described in section 1361(c)(7)'' in 
     paragraph (1) and inserting ``described in section 501(c)(3) 
     and exempt from taxation under section 501(a)'', and
       (2) by inserting ``Charitable Organizations Holding Stock 
     in'' after ``Applicable to'' in the heading.
       (c) ESOPs Allowed To Distribute Cash Rather Than Stock.--
       (1) In general.--Section 409(h)(2) of the Internal Revenue 
     Code of 1986 is amended by adding at the end the following 
     new subparagraph:
       ``(8) Plan maintained by s corporation.--In the case of a 
     plan established and maintained by an S corporation which 
     otherwise meets the requirements of this subsection or 
     section 4975(e)(7), such plan shall not be treated as failing 
     to meet the requirements of this subsection or section 401(a) 
     merely because it does not permit a participant to exercise 
     the right described in paragraph (1)(A) if such plan provides 
     that the participant entitled to a distribution from the plan 
     shall have a right to receive the distribution in cash.''
       (2) Conforming amendments.--Section 409(h)(2) of such Code 
     is amended--
       (A) by striking ``A plan'' and inserting:
       ``(A) In general.--A plan'', and
       (B) by striking ``In the case of an employer'' and 
     inserting:
       ``(B) Plans restricted by charter or bylaws.--In the case 
     of an employer''.
       (d) Exemptions From Prohibited Transaction Rules Available 
     to ESOPs and Shareholder Employees.--The last sentence of 
     section 408(d) of the Employee Retirement Income Security Act 
     of 1974 (29 U.S.C. 1108(d)) is amended by striking all that 
     precedes ``a participant or beneficiary'' and inserting ``For 
     purposes of this subsection,''.
       (e) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     1997.

     SEC. 3. AMENDMENTS RELATED TO SECTION 1042.

       (a) Extension of Section 1042 Principles to Stock Received 
     as Compensation for Services.--
       (1) In general.--Section 83 of the Internal Revenue Code of 
     1986 (relating to property transferred in connection with 
     performance of services) is amended by adding at the end the 
     following new subsection:
       ``(i) Exception for Transfers of Qualified Securities Sold 
     to Employee Stock Ownership Plans.--
       ``(1) Exclusion from income.--Subsections (a) and (b) shall 
     not apply to, and no amount shall be includible in gross 
     income with respect to, the transfer of any qualified 
     security (as defined in section 1042(c)(1)) in connection 
     with the performance of services if, and to the extent that, 
     within 60 days after the event which would cause the 
     recognition of income pursuant to subsection (a) or (b) but 
     for this subsection, the transferee sells such qualified 
     security to an employee stock ownership plan (as defined in 
     section 4975(e)(7)) and the requirements of section 1042(a) 
     are met with respect to such sale.
       ``(2) No deduction by employer.--Notwithstanding the 
     provisions of subsection (h), the person for whom the 
     services were performed in connection with which any 
     qualified security is transferred shall not be entitled to a 
     deduction with respect to such transfer if, and to the extent 
     that, paragraph (1) applies to such transfer.''
       (2) Conforming amendments.--
       (A) Section 424(c)(1) of such Code is amended by striking 
     ``or'' at the end of subparagraph (B), by striking the period 
     at the end of subparagraph (C) and inserting ``, or'', and by 
     adding at the end the following new subparagraph:
       ``(D) a sale to which section 1042 applies.''
       (B) Section 1042(a) of such Code is amended--
       (i) by striking ``which would be recognized as long-term 
     capital gain'' from the first sentence thereof, and
       (ii) by adding at the end the following new sentence: ``Any 
     gain which is recognized after the application of the 
     preceding sentence shall be treated as ordinary income to the 
     extent of the lesser of the amount of such gain or the amount 
     which would have been treated as ordinary income but for this 
     section.''
       (C) Section 1042(b)(4) of such Code is amended by adding at 
     the end the following

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     new sentence: ``The requirements of the preceding sentence 
     shall not apply to qualified securities received by the 
     taxpayer in a transfer to which section 83 or 422 applied (or 
     to which section 422 or 424 (as in effect on the day before 
     the date of enactment of the Revenue Reconciliation Act of 
     1990) applied).''
       (D) Section 1042(c)(1)(B) of such Code is amended to read 
     as follows:
       ``(B) were not received by the taxpayer in--
       ``(i) a distribution from a plan described in section 
     401(a), or
       ``(ii) a transfer pursuant to a right to acquire stock to 
     which section 423 applied.''
       (E) The first sentence of section 1042(d) of such Code is 
     amended to read as follows: ``The basis of the taxpayer in 
     qualified replacement property purchased by the taxpayer 
     during the replacement period shall be reduced by the amount 
     of gain not recognized by virtue of such purchase, taking 
     into account the application of subsection (a) and, if 
     applicable, the application of section 83(i) or section 
     424(c)(1)(D).''
       (F) Section 1042(e)(1) of such Code is amended to read as 
     follows:
       ``(1) In general.--If a taxpayer disposes of any qualified 
     replacement property, then, notwithstanding any other 
     provision of this title, gain (if any) shall be recognized to 
     the extent of the gain which was not recognized by reason of 
     the acquisition by such taxpayer of such qualified 
     replacement property, taking into account the application of 
     subsection (a) and, if applicable, the application of section 
     83(i) or 424(c)(1)(D). Such gain shall be treated as ordinary 
     income to the extent of the excess (if any) of the amount 
     which would have been treated as ordinary income but for the 
     application of such sections over the amount treated as 
     ordinary income under the last sentence of subsection (a).''
       (3) Effective date.--The amendments made by this subsection 
     shall apply to sales of qualified securities on or after the 
     date of the enactment of this Act.
       (b) Modification to 25-Percent Shareholder Rule.--
       (1) In general.--Section 409(n)(1)(B) of such Code is 
     amended to read as follows:
       ``(B) for the benefit of any other person who owns (after 
     the application of section 318(a)) more than 25 percent of--
       ``(i) the total combined voting power of all classes of 
     stock of the corporation which issued such employer 
     securities or of any corporation which is a member of the 
     same controlled group of corporations (within the meaning of 
     subsection (l)(4)) as such corporation, or
       ``(ii) the total value of all classes of stock of any such 
     corporation.''
       (2) Effective date.--The amendment made by paragraph (1) 
     shall take effect on the date of the enactment of this Act.

     SEC. 4. ESOP DIVIDENDS MAY BE REINVESTED WITHOUT LOSS OF 
                   DIVIDEND DEDUCTION.

       (a) In General.--Section 404(k)(2)(A) of the Internal 
     Revenue Code of 1986 (defining applicable dividends) is 
     amended by striking ``or'' at the end of clause (ii), by 
     redesignating clause (iii) as clause (iv), and by inserting 
     after clause (ii) the following new clause:
       ``(iii) is, at the election of such participants or their 
     beneficiaries--

       ``(I) payable as provided in clause (i) or (ii), or
       ``(II) paid to the plan and reinvested in employer 
     securities, or''.

       (b) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     1997.
                                 ______