The provision would eliminate Internal Revenue Code section 404(k), an incentive for ESOP creation and operation that permits a C corporation to deduct the value of dividends paid on ESOP stock passed through to employees in cash, deductions used to pay the ESOP acquisition loan, or when the employee reinvests in more company stock in his/her ESOP account balance, according to the ESOP Association.

So far, the proposal is unclear as to how big the ESOP sponsor would have to be before this tax benefit would be denied, Marcia S. Wagner, managing director of The Wagner Law Group, told PLANADVISER. But she notes that the deduction was never available to S corporation ESOP sponsors, which tend to be smaller companies.  “Perhaps the Administration was stung by the criticism of prior year budget proposals, which focused on S corporation sponsors,” she said.

J. Michael Keeling, ESOP Association president, said the Association is disappointed with the proposal and had no indication that the Obama Administration would introduce it. The proposal could reduce incentive to create and operate an ESOP, he said.

Wagner agrees that enactment of the latest proposal would put a damper on the formation of ESOPs by some companies. “But low dividend-paying employers should not be much affected,” she added.  

(Cont’d…)

Keeling said it is counterintuitive to eliminate an incentive for a policy that resulted in fewer layoffs during the Great Recession; according to the 2010 General Social Survey, employee stock owned companies laid off employees at a rate of 2.6% in 2010, whereas the rate for conventionally owned companies was 12.1%. (See “Employee Stock Owned Companies Had Fewer Layoffs.”) “It’s baffling to hear the Administration preach about creating jobs and then take away a proven policy that sustains jobs,” he added.  

Keeling speculates some version of the proposal has a chance of passing, but he thinks the current proposal laid out in Obama’s budget has no chance of moving forward. “His budget’s roadmap recommends changes in tax law to benefit large corporations, but it does not really address individual and American businesses, which are primarily pass through entities, subject to individual tax rates.”

Wagner said the IRS does not like extraordinary dividends, which could be the reasoning behind the 2014 budget proposal. A tax measure that can be presented as the elimination of a loophole stands a better chance of being passed, she added.

If the proposal passes as is, Keeling predicts problems in the future. “The long-term implications would be awful for the future of a very successful policy of encouraging a more inclusive capital ownership structure in America that can address job sustainability and income inequality, if the policy reasons cited for the proposal by the Administration become the policy of our national government,” he concluded.