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Each year, the employer makes a tax-deductible payment to the ESOP,
, sufficient to let the ESOP make its annual debt repayment to the bank:
The effect of this transaction is to allow the employer to borrow money from a lender and repay the loan with tax-deductible dollars. Since the principal and interest repayments are deducted before the employer's taxable income is determined, the taxable income is lower than through regular borrowing and the employer's taxes are reduced.
Since the major portion of the ESOP assets are used to buy employer stock, the value of each employee's ESOP benefit is directly tied to the financial success of the employer. Also, the employer, as a result of the use of an ESOP, benefits because employees understand that their work performance directly affects the financial success of the employer and the value of ESOP assets. After all, they now own part of the company.
Another benefit to the employer is that the ESOP provides its shareholders with a buyer for their stock if they wish to sell. For stockholders of a small employer, this is a tremendous advantage, and it could also assist the employer in attracting additional investors.
Summary The adoption of an ESOP provides benefits for the employer, its shareholders and its employees. Our tax laws encourage the establishment and use of ESOPs. Congress has passed five laws in the past 5 years to encourage
5 employers to consider ESOP. Will it continue? Senator Russell B. Long, chairman of the Senate Finance Committee, has repeatedly stated: “Just as in 1862, when Congress passed a law to allow Americans who had very little money to own and develop up to 160 acres of land, we should now give Americans the opportunity to become owners of our growing frontier of new capital (stock). The way to do this is through laws which encourage the development of programs like ESOP.”
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The bills discussed in this pamphlet, S. 3241 (introduced by Senator Robert C. Byrd for Senator Russell B. Long), S. 3291 (introduced by Senator Mike Gravel), and S. 3223 (introduced by Senator Mike Gravel) have been scheduled for a hearing on July 19 and 20, 1978, by the Senate Committee on Finance. S. 3241 and S. 3291 relate to employee stock ownership plans and S. 3223 relates to proposed general stock ownership trusts.
In connection with the hearing, the staffs of the Committee on Finance and the Joint Committee on Taxation have prepared a description of the bills. With respect to each bill, the description indicates the present law, an explanation of the provisions of the bill, its effective clate, and its possible revenue effect. II. EMPLOYEE STOCK OWNERSHIP PLANS-S. 3241
AND S. 3291 Present law Under present law, a corporate employer is entitled to an additional percentage point of investment credit (11 percent rather than 10 percent) if it contributes an amount equal to the additional credit to an employee stock ownership plan (ESOP) which satisfies the requirements of the Tax Reduction Act of 1975 (a Tax Reduction Act ESOP, or TRASOP). Up to 12 percent of extra investment credit is allowed where an employer contributes the extra credit to the TRASOP and the employer's extra contribution is matched by employee contributions. The present law provision for TRASOP contributions expires after December 31, 1980.
The employer's contribution to a TRASOP must be in the form of employer stock or cash (if the cash is used by the TRASOP to acquire employer stock). The employer stock may be stock of an affiliated employer and may be newly issued or previously outstanding.
No income tax deduction is allowed to an employer for contributions of investment tax credit to a TRASOP. Additional employer contributions to a TRASOP are deductible under the usual rules applicable to employee plans. Under the usual deduction rules, if an employer maintains a pension plan on the one hand and a profit-sharing or stock bonus plan on the other hand, deductions for aggregate employer contributions are generally limited to 25 percent of the compensation of employees covered by the plans. Deductions for contributions to a pension plan may exceed the 25-percent limit if the contributions are required by the minimum funding standard applicable to pension plans. Deductions are not allowed for estate tax or gift tax purposes, on account of a contribution to a qualified plan or TRASOP. Also, no deduction is ordinarily allowed to an employer for dividends paid on corporate employer stock.