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NCEO Provides Insights Into Tax Reform Impact

The National Center for Employee Ownership (the NCEO) recently offered some insights into the impact of tax reform on employee ownership, including ESOPs.

Although the tax reform provisions did not directly change any ESOP-specific laws, the Employee Ownership Update column by Loren Rodgers for December 21, 2017 (as updated on January 3, 2018), advises that certain general tax changes could have an impact on the considerations and mechanics of an ESOP transaction.

Specific tax reform provisions referenced in the column include:

  • New limitations on the deductibility of interest expenses. The tax legislation limits net interest deductions for businesses to 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA), and 30% of earnings before interest and taxes (EBIT) starting in 2022. The NCEO notes that a reduced interest expense deduction could raise taxable income for companies involved in leveraged ESOP transactions.

  • New treatment of state and local tax deductionsThe tax legislation imposes a limit of $10,000 on the amount of state and local taxes that are deductible for federal income tax purposes. According to the NCEO, the loss of the deduction for state and local income taxes, and the corresponding increase in federal taxable income in the year of a stock sale, may make an ESOP transaction with the potential for deferral of federal taxation (under Section 1042 of the Internal Revenue Code) more attractive.

  • New corporate tax rate for C corporations. The tax legislation reduces the corporate income tax rate from 35% to 21%, which will increase the appraised value of employer stock within the ESOP, and will accordingly increase the ESOP’s repurchase obligation. However, as the NCEO notes, for 100% S Corporation ESOPs (which pay no federal income taxes), the decreased corporate tax rate (and increased repurchase obligation) will not be accompanied by an increase in cash on hand.

  • New deduction for owners of S corporations. The tax legislation allows certain non-corporate owners of pass-through entities (such as S Corporations) to deduct 20% of “qualified business income.” The NCEO points out that this tax benefit could soften the tax advantages that ESOP ownership holds over non-ESOP ownership of an S Corporation.

Significantly, the NCEO recognizes that the accelerated pace of the legislation makes tax reform “a rapidly evolving issue” for taxpayers and their advisors, leaving key questions in need of further clarification.

The full update by the NCEO is available at the NCEO’s website.

About the Author

Andrew Bezouska is an attorney practicing out of our Madison office. He is a member of the Employee Benefits, Labor & Employment and Tax & Tax Advocacy practice groups. Contact Andrew by email or by phone at 608.252.9200.

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