[Congressional Record Volume 150, Number 94 (Friday, July 9, 2004)]
[Extensions of Remarks]
[Pages E1343-E1344]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




               ESOP PROMOTION AND IMPROVEMENT ACT OF 2004

                                 ______
                                 

                          HON. CASS BALLENGER

                           of north carolina

                    in the house of representatives

                          Friday, July 9, 2004

  Mr. BALLENGER. Mr. Speaker, I am introducing legislation today to 
promote employee ownership through employee stock ownership plans 
(ESOPs). Most of our colleagues are familiar with these plans, but are 
they aware that the most common form of providing stock ownership to 
non-managerial employees today is through ESOPs?
  During my service in the House, Congress has expanded employee 
ownership in America. I have worked to expand ownership through ESOPs 
by introducing, cosponsoring and advocating legislation. Many new 
provisions of ESOP law first surfaced in legislation I introduced in 
1990, 1991, 1993, and 1995. Through the years, I have worked to build 
bipartisan support for ESOPs in Congress.
  Let me say to my colleagues that ESOPs are not just special 
arrangements for the top executives in a company. ESOPs are broad-based 
stock ownership plans that, over the past 30 veers. have created 
significant wealth for employees. In many instances, they have been the 
innovators in participatory management practices that respect the 
individual while maximizing the performance of the company.
  Studies demonstrate that the overwhelming majority of employee-owned 
companies are more successful and treat their employees better than 
non-employee-owned companies. For example, in the most comprehensive 
study of ESOP companies ever done, over 1100 ESOP companies were 
matched against their counterparts for an eleven-year period. The ESOP 
companies had a survivability rate 15 percent greater than the non-ESOP 
companies, had annual sales 2.4 percent greater on average, and 
provided more retirement benefits than their counterparts. In another 
study, Washington State's Economic Development Office found in 1997 and 
1998 that ESOP companies in Washington State, when compared with non-
employee-owned companies, paid higher wages, had better retirement, and 
had twice the retirement income for employees.
  Despite all this favorable data, I cannot say that ESOP companies are 
always successful. But, I will say that they are usually high-
performing companies that share with employees the wealth they help 
create and bring a real ownership culture into the workplace.
  Overall, we have good ESOP laws on the books through our tax code and 
the Employee Retirement Income Security Act, which is overseen by the 
Department of Labor. My legislation does not unravel existing law, nor 
does it overreach with new, costly tax incentives for ESOP creation. 
Rather, my bill is a modest step toward aiding the creation of employee 
ownership through ESOPs and helping existing ESOP companies maximize 
their ownership structure.
  Primarily, the ESOP Promotion and Improvement Act of 2004 would make 
minor changes in tax law to treat S-corps the same as C-corps in the 
ESOP arena, which would help foster ESOP creation. My legislation would 
also extend to ESOPs some of the popular features accorded to 
retirement programs such as 401K's. Following is a brief explanation of 
my legislation:
  First, I will clarify what was really an oversight in the drafting of 
the 1997 law encouraging S corporations to sponsor ESOPs. The 1997 law 
prevented S corporations from taking a tax deduction for dividends 
(`distributions on current earnings'). Since S corporations do not pay 
a corporate level tax, it is reasonable not to give a corporate level 
tax deduction. However, under current law, distributions from current 
earnings on ESOP stock paid to employees of S-corps are subject to a 10 
percent penalty tax because the payments are treated as if they were 
early withdrawals from plan contributions to the ESOP. Clearly, 
Congress never intended for S corporations to have their dividends on 
ESOP stock treated more harshly than C corporation dividends paid on 
ESOP stock.
  To address this problem, my legislation does away with the unfair 10 
percent penalty and makes it clear that, as in C corporations, 
dividends paid by an S corporation on ESOP stock can be deducted if the 
deduction is used to pay the debt incurred to acquire the stock for the 
employees through the ESOP.
  Next, my legislation permits the owners of S corporation stock to 
sell that stock to an ESOP and, under tight rules, to defer the gain on 
that sale if the following conditions are met. First, the ESOP must 
hold at least 30 percent of the outstanding stock of the S corporation. 
Second, the seller must reinvest his or her proceeds in American 
companies. This treatment has been permitted for owners of C stock of a 
private company since 1984, and it has been a boon to ESOP creation. In 
fact, surveys by the ESOP Association show that 70 to 75 percent of the 
ESOP companies in America were created by exiting shareholders of 
private companies using this 1984 law. I believe that if this 
provision, Code Section 1042, is expanded to include S corporations, 
there will be many more S corporation ESOPs.
  I believe we also need to clarify a 1989 law that the IRS has 
stretched too far. Under an IRS regulation interpreting the corporate 
Alternative Minimum Tax (AMT), C corporation dividends that are paid on 
ESOP stock are calculated as part of a company's adjusted current 
earnings, which is used in calculating the corporate AMT. Three 
taxpayers have taken cases all the way to the Court of Appeals saying 
the IRS went beyond the reach of the law in this interpretation. 
However, the Courts have rejected these claims, stating that the IRS 
has wide discretion in promulgating regulations. We should reaffirm our 
commitment to ESOP creation and clarify that Congress never intended to 
make an ESOP benefit a tax liability by overturning these IRS rulings.
  Finally, my bill contains two technical amendments clearing up some 
unfair and out of date elements of the 1984 IRC 1042 provision. My bill 
clarifies who can participate in a 1042 ESOP, and it permits the 
proceeds from a 1042 sale to be invested in mutual funds of U.S. stock, 
versus requiring direct stock purchases. In addition, my bill brings 
parity to ESOPs with other defined contribution plans by permitting 
ESOP participants to withdraw money from the ESOP under limited 
circumstances to pay for a first-time home or college tuition.

[[Page E1344]]

  With these few provisions, my legislation will do much to advance the 
cause of employee ownership, making ESOPs more effective and fostering 
the creation of many more ESOP companies. I thank the House and my 
colleagues for their time, and I ask that they consider joining me by 
cosponsoring this legislation.

Section-by-Section Explanation of ESOP Promotion and Improvement Act of 
                                  2004

       Makes six amendments to the Internal Revenue Code to 
     improve the operation of existing ESOPs for both the plan 
     sponsor and the employee participants, and in some instances 
     make the creation of a new ESOP easier and more attractive.
       Section 1. Clarifies that the 1996 and 1997 laws permitting 
     S corporations to sponsor employee ownership through ESOPs 
     allows S corporation distributions on current earnings 
     (referred to as dividends in C corporations) on ESOP shares 
     to be utilized in the same way as dividends under a 1984 law 
     and 1986 law applying to dividends in a C corporation. 
     Specifically, this section would permit the distributions 
     from current earnings by an S corporation on ESOP stock to be 
     passed through to employees without the 10 percent early 
     withdrawal tax currently imposed on the employees. It would 
     also permit distributions on current earnings on ESOP stock 
     to be used to pay the ESOP acquisition debt. Regular income 
     tax will still be due and, in keeping with current law, the S 
     corporation would not be permitted a tax deduction for the 
     distributions from current earnings on ESOP stock. *(The 
     distributions from current earnings are not to be confused 
     with regular contributions to the ESOP by the S corporation 
     which would still continue to be subject to early withdrawal 
     penalties if withdrawn by an employee before death, 
     termination, disability, or retirement.)*
       Section 2. Permits the seller of stock to an S corporation 
     ESOP to utilize the current law ESOP tax deferral rollover 
     tax benefit (IRC 1042), under the same restrictions applied 
     to sellers to C corporation ESOPs. In general, to take 
     advantage of IRC 1042, the ESOP most hold at least 30 percent 
     of the corporation's highest class of stock at close of 
     transaction, and the seller must reinvest the proceeds of the 
     sale into the equities of operating U.S. corporations. If 
     these conditions and others are met, the seller may defer the 
     capital gains tax on his or her proceeds until he or she 
     disposes of the qualified replacement property acquired with 
     the sale proceeds. Furthermore, the benefit is applicable 
     only to sales of non-publicly traded stock.
       Section 3. Reverses a series of federal court decisions 
     that have upheld a 1989 regulation by the Internal Revenue 
     Service that includes tax deductions taken for dividends paid 
     on ESOP stock when calculating a C-corp's AMT liability. This 
     IRS regulation imposes the corporate AMT under an 
     interpretation of IRC Section 56 that deductible ESOP 
     dividends are included under the preference item known as 
     ACE, or adjusted current earnings. Despite reasoned 
     challenges to the IRS regulation by three taxpayers, courts 
     have upheld the IRS regulations.
       Section 4. Makes two minor changes to IRC Section 1042 
     (first enacted in 1984). The changes would make this ESOP tax 
     benefit more reasonable, particularly due to developments 
     since its enactment. Specifically, this section permits the 
     proceeds from a 1042 sale to be reinvested in mutual funds 
     that are invested in U.S. equities, and provides that an 
     owner of 25 percent or more of one class of non-voting stock 
     will not be automatically prohibited from participating in an 
     ESOP with 1042 securities, and aggregates the 25 percent 
     owner restriction on participation in a 1042 ESOP to all of 
     the outstanding shares of the corporation, not just one class 
     of shares.
       Section 5. Permits early withdrawals from ESOPs (as with 
     other ERISA plans) for purposes of a first time home purchase 
     or payment of college tuition, with various restrictions, 
     including that the withdrawal may not be more than 10 percent 
     of an account balance, and the individual has had to 
     participate five years in the ESOP.

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