Rangel’s Corporate Tax Proposal

Rangel's Corporate-Tax Bill May Frame Future Debate discusses how the "top tax writer is calling for a cut in the corporate income-tax rate, but would replace the lost revenue with other tax changes that would hit businesses." While the proposal is unlikely to make it through Congress, it sets the stage for a 2009 debate:

"The proposal, which Mr. Rangel plans to introduce later this week as part of a broad tax bill, is unlikely to make it through Congress this year, a fact even he has acknowledged. Still, it sets the stage for a future debate about taxes and could provide fodder for a broader overhaul when a new president takes office in 2009."

This is an area of concern for ESOPs. Rangel's tax proposal is similar to the Treasury Department report released in July and discussed in a recent ESOP Government Update:

"The report provided that if "special provisions" were eliminated, the corporate tax rate could be reduced from 35% to 27% without affecting overall tax revenue. One of the "special provisions" mentioned is "Special ESOP Rules". The "Special ESOP Rules" make up $23 billion of the $1,241 trillion (1.85%) of "special provisions"."

The ESOP Association posted a Legislative Alert on their blog: House Ways and Means Committee Proposes Cutback in Benefits of Stock Options in S ESOP Companies

"While precise legislative language is not available at this time, a summary of legislation introduced today by Chair of the House Ways and Means Committee, Charles Rangel [D-NY], has as a so-called loophole closer, a provision that impacts an S ESOP corporation's granting stock options to employees. Note, the proposal does not impact the underlying tax treatment of the S corporation's taxable income pro rated to the ESOP's ownership share."

The Alert clarified that the proposal "did not endorse the more anti-ESOP proposal embedded in the Treasury Department recommendation in August." The proposal "will supposedly raise $600 million over ten years, or a mere $60 million per year, in order to help pay for a near $400 billion reduction in corporate income taxes due to a proposed rate cut in the C corporation current rate of 35% to 30.5%, a proposal initiated by the Administration."

Here is the language from the proposal:

"Recognition of ordinary income on exercise of stock options in S corporation with an ESOP. Under current law, an individual that holds an option in an S corporation is not subject to tax on the income of the S corporation until such individual exercise their option and becomes a shareholder in the S corporation. During the period of time in which an individual holds an option in an S corporation, taxes on the income earned by the S corporation are intended to be paid by the other shareholders in the S corporation. However, a portion of the S corporation's earnings will never be subject to tax if one of the shareholders in the S corporation is a tax-exempt employee stock ownership plan (an "ESOP"). Certain taxpayers have taken advantage of these aspects of current law by having a tax-exempt ESOP hold a significant percentage of an S corporation's stock while taxable individuals hold stock options. The combined effect of this structure is that taxable investors are able to benefit from appreciation in the value of the S corporation while a significant portion of the S corporation's income completely avoids tax. The bill would require these option holders to recognize income when an option is recognized or sold in an amount equal to the amount of income that was shifted to the ESOP through this type of tax planning during the period of time that the option was held buy such taxpayer. Interest will be assessed at the underpayment rate on any amounts included under this provision. This proposal is estimated to raise $606 million over 10 years."

For another look at the proposal, check out Giant tax overhaul bill unveiled