Executives, managers and employees of closely held businesses in Chicago and all over the country may soon become more likely to own part of their employers. On March 29, 2011 several Congressmen, both Democratic and Republican, introduced H.R. 1244, the Promotion and Expansion of Private Employee Ownership Act of 2011. On April 15, 2011, the bill was referred to the Education and Workforce Committee, the first step on the process before a vote. There is a similar bill pending in the Senate Finance Committee, the Employee Stock Ownership Plan Promotion and Improvement Act of 2011, S. 101. The bills effectively give incentives to owners of closely held businesses formed as a Subchapter S corporation to transfer ownership of the company to an Employee Stock Ownership Plan (“ESOP”), and incentives to lenders who loan the corporation money to purchase the stock from the owner.
Many small businesses structured as Subchapter S corporations have already created ESOPs. But if enacted, the House Bill would make forming an ESOP by an S corporation even more attractive. The bill would allow owners of an S corporation to defer the gain realized on the sale of stock to the ESOP in the same way as currently allowed for owners of C corporations by amending I.R.C. § 1042(c)(1) to define qualifying securities as including those of S corporations, not just C corporations. Moreover, the bill would allow lenders that loan money to an S corporation for the purposes of purchasing the corporation’s stock for the ESOP to deduct half the interest received, thereby incenting lenders to participate in these leveraged ESOPs.
Congress appears to have two things on its mind. First, as expressly noted in its findings, “40 percent of working Americans have no formal retirement account at all”. Second, with a Baby-Boomer population at or nearing retirement, many owners of small to medium-size are succession planning. There would likely be an abnormally large number of businesses for sale. This may give those business owners increased incentive to pass the businesses along to their employees rather than sell the business on the open market, and incurring immediate tax liability.
We are excitedly monitoring the progression of this bill. With all change comes opportunity, for the better and worse. There will always be a few bad apples in the bunch, With increased benefits to owners for selling their stock to an ESOP, there will undoubtedly increased number of attempts to sell the stock to the employee benefit plan for an inflated price. Luckily, with the pending changes to the DOL’s definition of fiduciary, as covered in an earlier post, to possibly encompass valuation experts, this may be mitigated. If you have questions about your employer creating and ESOP, call an ERISA lawyer.
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