ESOP Group Warns House Small Business Panels of Threat to ESOPs in Tax Reform Plan

We are pleased that the Small Business Subcommittees on Rural Enterprises, Agriculture and Technology and Tax, Finance and Exports have joined to examine the recommendations put forth by the President's Advisory Panel on Federal Tax Reform [the Panel].

As the trade association representing companies with ESOPs and their employee owners, we find the recommendations to be shocking, and contra to the Administration's previous posture towards employee ownership. The recommendations fly in the face of over thirty years of Presidential and Congressional support of broadened ownership, of both Republican and Democratic Administrations.

Since there is some confusion over the specific recommendations of the Panel that would eliminate ESOPs, it is important to explain how the Panel's recommendations would eliminate all ESOPs. Specifically on pages 61, 93, 108, 115, and 157, the Panel recommends that all ERSA defined contribution plans in current law be eliminated from the tax code, and in lieu thereof, there be one type of plan named by the Panel as a "Save at Work," plan which resembles a 401(k) plan. An ESOP is a defined contribution plan, and the description of the new "Save at Work" plan does not describe an ESOP -- ergo the Panel's "Save at Work" recommendation eliminates ESOPs.

Top members of the Panel state that there was "no intent" to eliminate ESOPs and it is now obvious that leaders of the Panel were not aware of the impact in ESOPs. Senior staff of the Panel say that "the Panel did not get into details, and so did not address ESOPs." Thus, intentional, or unintentional, the impact of the Panel's defined contribution proposal is the same -- if adopted, no ESOPs.

In meetings with senior Treasury Department tax policy officials, who are reviewing the Panel's recommendations, elected leaders of the Association were told it was "irrelevant" as to why the Panel recommended a policy that would mean no more ESOPs, as the Treasury Department personnel are taking the Panel's recommendations at face value, and not trying to be psychics in discerning the Panel's hidden reasons behind certain recommendations.

The Small Business Subcommittees should seriously consider the ramifications of the Panel's recommendations and the impact on the millions of Americans who own and work for small businesses. ESOPs encourage entrepreneurship, productivity, and American competitiveness on both a corporate and individual scale and promote an ownership society, where many average income citizens are owners.

Furthermore, small businesses dominate the ESOP world. In fact, 82% of ESOP Association members have less than 250 employees and 92% have less than 500 employees. These demographics can also be applied to non-member companies as economic figures show that the majority of companies in the U.S. are small businesses.

The ESOP Association recognizes that current Federal tax law encourages and promotes employee ownership through ESOPs, and that in the 30 plus years these laws have existed, employee ownership through ESOPs has in the overwhelming majority of instances provided significant wealth to employee owners, and has in the overwhelming majority of instances made the employee-owned companies high performing companies in comparison to their non-employee-owned competitors.

Here's why ESOPs should have been considered by the Panel; with a desire to increase employee ownership:

• Since 1974, ESOPs have been the primary tool to broaden ownership of American business among employees.

• There are approximately 11,000 ESOPs in place in the U.S., covering 10 million employees (10% of the private sector workforce).

• An estimated 8 to 11 million Americans have accounts in ESOPs.

• Total assets owned by U.S. ESOPs were estimated to be $600 billion at the end of 2004.

• In 2005, the Employee Ownership Foundation, conducting its 14th Annual Economic Performance Survey (EPS), found that a very high percentage of companies, 87.5%, declared that creating employee ownership through an ESOP (employee stockownership plan) was "a good decision that has helped the company." In addition, the EPS asked companies to indicate their performance in 2004, relative to 2003. Approximately 74% of respondents indicated a better performance in 2004 than 2003, 9% indicated a nearly identical performance, and 17% indicated a worse performance. Approximately 84% indicated that revenue increased while 16% indicated revenue did not increase. In terms of profitability, 74% indicated that profitability did increase and 26% indicated that profitability did not increase in 2004.

Also, we note that 850 of the Association's 1,400 members are S corporations. As the Committee has probably heard from the millions of small businesses that are so called "pass through" entities for Federal tax purposes, the Panel's recommendations for a corporate level tax on all businesses with receipts over $10.5 million per annum does not sit well with these 850 ESOP companies, as under current law, passed in 1997, and heavily debated in 1999 and 2000, income of an S corporation sponsoring an ESOP pro rated to the ESOP's share of the corporation's annual taxable income is not taxed at the corporate level, but at the individual level only when the individual receives a distribution from the ESOP in accordance with ERISA law. On behalf of our S corporation members, not only do we urge a total rejection of any proposal to eliminate ESOPs, we urge maintaining current tax law treatment of S corporation ESOPs and rejection of any wrongheaded plan to snuff out employee ownership through ESOPs.

We thank you for holding this hearing and ask you in your deliberations to look closely at the impact these recommendations will have on the millions of small business owners and their employees in the U.S.