ESOPs Fables: What Does the Omnibus Do for Employee Ownership?

SECURE 2.0 and the WORK Act, both found in the appropriations package, would reform ESOPs with the aim of making them easier to start.

The omnibus spending bill currently being debated in Congress contains two bills that would reform employee stock ownership plans, the WORK Act and the SECURE 2.0 Act. If the budget is passed by the end of this week, as anticipated, these two bills will become law.

ESOPs are a qualified 401(a) retirement plan invested in the stock of the sponsoring company. Offered by some corporations, ESOPs are often intended to improve employee commitment to the health of a company by enabling employees to benefit from company growth. ESOP funds are managed by a trustee.

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The Worker Ownership, Readiness and Knowledge (WORK) Act, initially sponsored by Senator Bernie Sanders, I-Vermont, and Senator Jerry Moran, R-Kansas, contains two key reforms for ESOPs. The first would provide $50 million in funding for the Department of Labor to give grants to state and local governments for improving knowledge of and about ESOPs. If a state does not apply for the funding within one year, then a nonprofit can apply on behalf of that state to promote ESOP outreach.

Corey Rosen, founder of the National Center for Employee Ownership, says “lack of knowledge is a huge barrier” for businesses that might be interested in ESOP creation. Many do not know that the plan type exists and, if they do, may not know how to start one.

The second provision in the WORK Act related to ESOPs instructs the DOL to establish regulations for properly appraising the value of the company stock to be sold to ESOP plans. Currently there are no guidelines for such valuation, which creates a litigation risk.

Rosen explains that it is hard for businesses to follow rules that do not exist, and ESOPs can be vulnerable to lawyers who are just “trying to find a settlement.” The DOL writing formal regulations for valuation should bring more legal certainty to sponsors of ESOPs, sources said.

Noelle Montano, executive director of Employee-owned S Corporations of America, explains that the absence of DOL regulations on valuation is a “longtime concern” and ESOP advocates have been calling for a formal DOL rulemaking process on valuation for many years. Montano says the DOL has been relying on audits and litigation and that the industry want “rules of the road.” Now they are set to get them.

The SECURE 2.0 Act also contains two provisions relevant to ESOPs. Under current law, only shareholders in C Corporations are allowed to defer 100% of their tax liability from gains when they sell their stock to an ESOP, provided they invest those gains in the stocks or bonds of another U.S. company.

The SECURE 2.0 Act would also allow shareholders in S Corporations to defer taxes in the same fashion when selling to an ESOP. However, they could only defer 10% of their gains upon investing in other stock. Rosen explains that only allowing a 10% deferral instead of 100% deferral was designed to reduce the bill’s total cost to the federal government in terms of lost tax revenue.

An aide from the House Ways and Means Committee confirmed this to PLANSPONSOR, saying, “the cost of this provision was high.” The aide said there is interest in expanding this tax treatment to reach parity between S and C corporations, but they “can only afford 10%.” House Ways and Means Chairman Richard Neal, D-Massachusetts, said in a call with reporters Wednesday that SECURE 2.0 was scored at costing $53 billion and is fully offset by corresponding tax revenues.

The other relevant provision in SECURE 2.0 says that if the shares of an ESOP sponsor trade in unlisted markets but meet criteria for frequency of trading, then they would not have to undergo a formal valuation to set the value of their ESOP stocks.

Publicly traded companies do not need full valuations because those values can be deduced from the market value of their shares. However, corporations that trade on unlisted venues lack that transparency because they are traded less frequently. The provision would allow those corporations with adequate trading volume on unlisted venues to avoid the process of a formal appraisal to start an ESOP plan.

Rosen explains that this provision would mostly apply to small community banks, since ESOPs are common among them, and some are traded on unlisted markets. He calls it a “very narrow provision.”

CBO Forecasts 23% Social Security Shortfall by 2034

A bipartisan federal agency warns that workers may see a 23% reduction in promised Social Security benefits by 2034 if no tax increases, benefit cuts or some combination are made before then.

The latest long-term Social Security projections from the Congressional Budget Office say the federal government may not be able to meet the full amount of scheduled benefits as early as the next decade.

In the report released Friday, the bipartisan federal agency said that two trust funds used to pay for Social Security and payroll taxes will be depleted by 2033, resulting in a 23% cut in planned benefit payments in 2034.

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The budget forecast comes even as Congress weighs the passage of retirement policy known as SECURE 2.0 in an omnibus spending package expected to be voted on this week. The forecast adds to retirement industry voices and surveys noting that current and soon-to-be retirees may face retirement income shortfalls, in part due to historically low interest rates, combined with rising inflation.

In 2034, the CBO projects revenues to equal 77% of the program’s scheduled payments, resulting in a 23% shortfall for retirees. The gap between scheduled and payable benefits would widen to 35% by 2096, and remain stable thereafter, according to the Washington DC-based agency.

Social Security is financed by payroll taxes and income taxes on benefits that are credited to two trust funds collectively known as the Old-Age, Survivors and Disability Insurance (OASDI) funds. The payroll tax is generally 12.4% of earnings up to a maximum annual amount, with workers and employers each paying half, and self-employed workers paying the full amount, according to the CBO. In addition to tax revenues, the trusts earn interest payments on the Treasury securities they hold.

The CBO said it expects real earnings—meaning adjusted for inflation—to rise in coming years, which would in turn mean larger payouts for initial Social Security benefits that are paid based on a person’s earnings history. This growth would be partially offset by a recent change in the age when people can receive 100% of their Social Security benefits, which was moved to 67 years old instead of 65 for people born after 1959.

Even with the offset, the CBO found that if Social Security benefits are paid out as scheduled, the program would increase from 5.0% of gross domestic product in 2022 to 7.0% in 2096, with revenues remaining around just 4.6% over the same period. That discrepancy would lead to a depletion of the trust fund coffers within the next decade—a potential hit to retirement income for tens of millions of Americans.

The CBO did give some options to push the gap out to 2096. The report said the federal government could “immediately and permanently” raise the payroll tax rates by about 4.9% to keep the trusts funded until near the end of the century, when the trusts would again face a gap. The government could also, the report said, implement an equivalent reduction in benefits, or do a combination of tax increases and benefit reductions.

Within the retirement industry, lifetime income annuities are often cited as a strong hedge against the potential of Social Security or other retirement savings falling short of expectations. On Tuesday, the annuities trade association LIMRA put out a survey showing that a plurality (49%) of annuity buyers will use the life insurance product to generate income either to supplement Social Security or a pension.

People generally buy annuities for income, expense management, asset accumulation and legacy focus to pass on to inheritors, according to the Windsor, Connecticut-based LIMRA.

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