...Rising Support for ESOP Legislation
Within the employee ownership community, excitement is in the air—and for good reason. Employee ownership advocates are gaining inroads with federal and state legislators on a number of issues intended to promote employee ownership. “I have been involved in this field for 40 years,” says Corey Rosen, founder of the National Center for Employee Ownership (NCEO), “and I have never seen such a tremendous confluence of legislative activity as we are seeing now.”
Given the significant optimism and interest noted recently within this community—which comprises employee stock ownership plans (ESOPs), worker cooperatives, and employee ownership trusts—business owners are turning their attention to employee ownership as a means to strengthen local communities and provide wealth for current owners and future employee owners. In order to understand the current landscape, let’s take a look at the roots of employee ownership.
Employee Ownership: Then and Now
The modern form of employee ownership started with Lou Kelso, who designed and implemented the first ESOP in 1956. About 300 ESOPs were formed in the next eighteen years, with each one typically requiring a private letter ruling from the IRS. In 1974, ESOPs became part of federal law with the passage of the Employee Retirement Securities Act. Notable pro-ESOP legislation in the decades that followed includes the Section 1042 capital gains deferral (in the Tax Reform Act of 1986) and the income tax exemption for S corporation ESOPs (in 1997).
Along the way, a number of organizations—from stalwarts such as the NCEO, the ESOP Association, and Employee-Owned S Corporations of America (ESCA) to newcomers such as the Employee Ownership Exchange (EOX), Ownership America, Project Equity, and Certified Employee-Owned—have helped advance employee ownership initiatives at all levels of government. Recently, the NCEO hosted a conversation with a handful of community leaders on the topic of current employee ownership legislation. Some takeaways from that conversation include the following:
- Employee ownership continues to enjoy bipartisan support.
- ESOPs are the most widely adopted employee ownership option because they are tax advantaged, but co-ops and employee ownership trusts are also gaining popularity.
- Ordinary citizens, as opposed to high-powered lobbyists, have recently introduced state-level bills to their legislators.
- Colorado is seen as a model state with regards to employee ownership (Colorado’s model is detailed later in this article).
What’s New and Exciting at the Federal Level?
RISE and SHINE Act
At the federal level, the Senate Health Education Labor and Pension Committee passed S 4353, the Retirement Improvement and Savings Enhancement to Support Healthy Investments for the Nest Egg (RISE and SHINE) Act in June 2022. This bipartisan bill, jointly sponsored by Committee Chair Patty Murray (D-WA) and Ranking Member Richard Burr (R-NC), promotes employee ownership through education and outreach with grants of up to $50 million for states and localities. It also requires the U.S. Secretary of Labor to issue regulations on the standards and procedures for establishing good-faith fair market value for the purchase of sponsor company shares by an ESOP. If it becomes law, the RISE and SHINE Act will create the first federal grant program dedicated to promoting employee ownership.
On March 31, 2022, the House passed HR 2954, the Securing a Strong Retirement Act (SECURE 2.0), which contains two provisions that help ESOPs: Section 117 allows S corporation owners to defer up to 10 percent of capital gains on the sale of stock to an ESOP under Section 1042 of the Internal Revenue Code. And Section 118 of SECURE 2.0 clarifies the definition of a “publicly traded employer security” for ESOP sponsor companies that trade over the counter.
For employee ownership advocates, the 10 percent capital gains tax deferral is a step in the right direction (a more significant step is outlined below, under HR 4141).
2022 National Defense Authorization Act
Section 874 of the 2022 National Defense Authorization Act (NDAA) creates a five-year pilot program that authorizes sole-source awards to companies wholly owned by ESOPs for follow-on defense contracts. Although the language in Section 874 does not go so far as to require Department of Defense contracting agents to provide contract advantages to ESOPs, early indications are favorable for this program.
On June 24, 2021, the House introduced HR 4141, the Promotion and Expansion of Private Employee Ownership Act of 2021, designed to expand the availability of ESOPs in S corporations by providing the following three benefits:
- Amending the Internal Revenue Code to make the capital gains tax deferral on sales to ESOPs (as outlined in Section 1042 of the Code) available to S corporation owners (i.e., 100 percent of the capital gains could be deferred)
- Allowing S corporations to deduct interest expenses from qualified securities acquisition loans
- Establishing the S Corporation Employee Ownership Assistance Office to foster increased employee ownership of S corporations
Details and the current status of HR 4141 are available at https://www.congress.gov/bill/117th-congress/house-bill/4141?r=59&s=1; a similar version of this bill was introduced in the Senate. The HR 4141 tax incentives are currently available to C corporations and C corporation shareholders. The proposed legislation would make ESOP installations more feasible for S corporation business owners.
State Small Business Credit Initiative
The American Rescue Plan Act of 2021 included a $10 billion appropriation for another round of funding for the State Small Business Credit Initiative (SSBCI). The SSBCI was created in 2010 to make capital available for economic development through small businesses. The majority of SSBCI funding is made available to states, and states are expected to leverage the funds on a 10:1 basis.
Historically, equity purchases have not qualified for SSBCI capital allocations. However, Congress recommended the Department of the Treasury include specific language in the SSBCI capital program policy guidelines for the purchase of to purchase majority business ownership interests by ESOPs, worker cooperatives, or other related vehicles.
What’s New and Exciting at the State/Local Level?
State governments have been active as well, introducing legislation that generally seeks to achieve the following initiatives:
- Create a government-sponsored state employee ownership center.
- Provide tax incentives for selling shareholders, sponsor companies, and/or lenders.
- Provide grants/tax credits for technical assistance (e.g., feasibility studies).
- Provide easier access to capital.
- Allow ESOPs to maintain status and/or qualify for state set-aside programs.
- Allow ESOPs to own professional corporations .
Colorado is considered the poster child for state legislation on employee ownership. In April 2019, Colorado established an Employee Ownership Office to provide a peer network for current and prospective employee-owners and an employee ownership certification for businesses with at least 20 percent ownership held by workers.
Colorado also provides employee ownership tax credits (covering up to half of a qualified business’s ESOP conversion costs up to $50,000) and grants to reimburse small businesses for professional services fees related to restructuring as an employee-owned company.
In September 2022, the California Employee Ownership Act was signed into law. The act establishes the California Employee Ownership Hub within the Office of Small Business Advocate to increase awareness and understanding of employee ownership among stakeholders, assist business owners and employees in navigating available resources, and streamline and reduce barriers to employee ownership.” The current bill was scaled back due to budget cuts. Its initial version, passed by the California House, included appropriations for outreach, financing, and technical assistance for conversions to employee ownership.
In April 2022, the Maine legislature passed LD 1969. This law requires the Public Utilities Commission to “consider whether a majority of the individuals working on an assisted project are members of an entity that is employee-owned, including but not limited to an entity that offers employee stock ownership plans.”
Massachusetts resurrected its employee ownership center (which existed in the 1990s but lost funding in 1999) in 2019, when legislators restored funding for the office. In 2021, a pending bill (S 261) was introduced to make the state center a permanent part of the Massachusetts Office of Business Development.
In May 2022, New York State passed a bill to allow architectural, engineering, and land survey ESOP sponsor companies to qualify under the state’s business corporation law for professional corporations (see Senate Bill S5261B at https://www.nysenate.gov/legislation/bills/2021/s5261).
Pennsylvania, Tennessee, and Texas
Pennsylvania, Tennessee, and Texas legislators introduced bills similar to the Colorado bill, to provide similar (and greater) assistance to businesses in converting to employee ownership. These bills are as follows:
- Pennsylvania LPRO 3835
- Tennessee SB 1974: https://legiscan.com/TN/bill/SB1974/2021
- Texas HB 2246: https://legiscan.com/TX/bill/HB2246/2021
In September 2019, Pittsburgh launched the nation’s first citywide task force on employee ownership. The task force is charged with assessing the economic landscape in the Council Districts of Pittsburgh to determine the opportunities and challenges for creating employee-owners. The task force provides direct employee ownership outreach to the city’s 30,000 businesses.
More Than Just a Good Thing
Although ESOPs have always enjoyed bipartisan support, lawmakers are demonstrating their growing support for employee ownership by passing and introducing pro-ESOP bills. With all the recent enthusiasm and progress , the NCEO has begun providing monthly updates to track the most promising employee ownership legislation at the federal level (https://www.nceo.org/article/federal-legislation-esops) and the state level (https://www.nceo.org/article/state-legislation-employee-ownership-0).
The message of employee ownership is resonating throughout the country and on both sides of the political aisle. Employee ownership is not just a “good thing” for employees but a powerful tool for stabilizing local communities and confronting wealth inequality.