The Congressional Record is a unique source of public documentation. It started in 1873, documenting nearly all the major and minor policies being discussed and debated.
“ESOP PROMOTION AND IMPROVEMENT ACT OF 2004” mentioning the U.S. Dept of Labor was published in the Extensions of Remarks section on pages E1343-E1344 on July 9, 2004.
The publication is reproduced in full below:
ESOP PROMOTION AND IMPROVEMENT ACT OF 2004
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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.
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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