II

106TH CONGRESS

1ST SESSION S. 1732

To amend the Internal Revenue Code of 1986 to prohibit certain allocations

of S corporation stock held by an employee stock ownership plan.

IN THE SENATE OF THE UNITED STATES

OCTOBER 14, 1999

Mr. BREAUX (for himself, Mr. JEFFORDS, Mr. GRASSLEY, Mr. KERREY, and

Mr. HATCH) introduced the following bill; which was read twice and referred to the Committee on Finance

A BILL

To amend the Internal Revenue Code of 1986 to prohibit

certain allocations of S corporation stock held by an

employee stock ownership plan.

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,

3 SECTION 1. PROHIBITED ALLOCATIONS OF S CORPORA4 TIONS STOCK HELD BY AN ESOP.

5 (a) IN GENERAL.—Section 409 of the Internal Rev6 enue Code of 1986 (relating to qualifications for tax credit

7 employee stock ownership plans) is amended by redesig8 nating subsection (p) as subsection (q) and by inserting

9 after subsection (o) the following new subsection:
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1 ‘‘(p) PROHIBITED ALLOCATIONS OF SECURITIES IN

2 AN S CORPORATION.—

3 ‘‘(1) IN GENERAL.—An employee stock owner4 ship plan holding employer securities consisting of

5 stock in an S corporation shall provide that no por6 tion of the assets of the plan attributable to (or allo7 cable in lieu of) such employer securities may, dur8 ing a nonallocation year, accrue (or be allocated di9 rectly or indirectly under any plan of the employer

10 meeting the requirements of section 401(a)) for the

11 benefit of any disqualified person.

12 ‘‘(2) FAILURE TO MEET REQUIREMENTS.—

13 ‘‘(A) IN GENERAL.—If a plan fails to meet

14 the requirements of paragraph (1), the plan

15 shall be treated as having distributed to any

16 disqualified person the amount allocated to the

17 account of such person in violation of para18 graph (1) at the time of such allocation.

19 ‘‘(B) CROSS REFERENCE.—

‘‘For excise tax relating to violations of paragraph

(1) and ownership of synthetic equity, see section

4979A.

20 ‘‘(3) NONALLOCATION YEAR.—For purposes of

21 this subsection—

22 ‘‘(A) IN GENERAL.—The term ‘nonalloca23 tion year’ means any plan year of an employee
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1 stock ownership plan if, at any time during

2 such plan year—

3 ‘‘(i) such plan holds employer securi4 ties consisting of stock in an S corpora5 tion, and

6 ‘‘(ii) disqualified persons own at least

7 50 percent of the number of shares of

8 stock in the S corporation.

9 ‘‘(B) ATTRIBUTION RULES.—For purposes

10 of subparagraph (A)—

11 ‘‘(i) IN GENERAL.—The rules of sec12 tion 318(a) shall apply for purposes of de13 termining ownership, except that—

14 ‘‘(I) in applying paragraph (1)

15 thereof, the members of an individ16 ual’s family shall include members of

17 the family described in paragraph

18 (4)(D), and

19 ‘‘(II) paragraph (4) thereof shall

20 not apply.

21 ‘‘(ii) DEEMED-OWNED SHARES.—Not22 withstanding the employee trust exception

23 in section 318(a)(2)(B)(i), for purposes of

24 determining whether an individual is a dis-
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1 qualified person, such individual shall be

2 treated as owning deemed-owned shares.

3 ‘‘(4) DISQUALIFIED PERSON.—For purposes of

4 this subsection—

5 ‘‘(A) IN GENERAL.—The term ‘disqualified

6 person’ means any person if—

7 ‘‘(i) the aggregate number of deemed8 owned shares of such person and the mem9 bers of such person’s family is at least 20

10 percent of the number of deemed-owned

11 shares of stock in the S corporation, or

12 ‘‘(ii) in the case of a person not de13 scribed in clause (i), the number of

14 deemed-owned shares of such person is at

15 least 10 percent of the number of deemed16 owned shares of stock in such corporation.

17 ‘‘(B) TREATMENT OF FAMILY MEMBERS.—

18 In the case of a disqualified person described in

19 subparagraph (A)(i), any member of such per20 son’s family with deemed-owned shares shall be

21 treated as a disqualified person if not otherwise

22 treated as a disqualified person under subpara23 graph (A).

24 ‘‘(C) DEEMED-OWNED SHARES.—For pur25 poses of this paragraph—
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1 ‘‘(i) IN GENERAL.—The term

2 ‘deemed-owned shares’ means, with respect

3 to any person—

4 ‘‘(I) the stock in the S corpora5 tion constituting employer securities

6 of an employee stock ownership plan

7 which is allocated to such person

8 under the plan, and

9 ‘‘(II) such person’s share of the

10 stock in such corporation which is

11 held by such plan but which is not al12 located under the plan to participants.

13 ‘‘(ii) PERSON’S SHARE OF

14 UNALLOCATED STOCK.—For purposes of

15 clause (i)(II), a person’s share of

16 unallocated S corporation stock held by

17 such plan is the amount of the unallocated

18 stock which would be allocated to such per19 son if the unallocated stock were allocated

20 to all participants in the same proportions

21 as the most recent stock allocation under

22 the plan.

23 ‘‘(D) MEMBER OF FAMILY.—For purposes

24 of this paragraph, the term ‘member of the

25 family’ means, with respect to any individual—
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1 ‘‘(i) the spouse of the individual,

2 ‘‘(ii) an ancestor or lineal descendant

3 of the individual or the individual’s spouse,

4 ‘‘(iii) a brother or sister of the indi5 vidual or the individual’s spouse and any

6 lineal descendant of the brother or sister,

7 and

8 ‘‘(iv) the spouse of any individual de9 scribed in clause (ii) or (iii).

10 A spouse of an individual who is legally sepa11 rated from such individual under a decree of di12 vorce or separate maintenance shall not be

13 treated as such individual’s spouse for purposes

14 of this subparagraph.

15 ‘‘(5) TREATMENT OF SYNTHETIC EQUITY.—For

16 purposes of paragraphs (3) and (4), in the case of

17 a person who owns synthetic equity in the S corpora18 tion, except to the extent provided in regulations, the

19 shares of stock in such corporation on which such

20 synthetic equity is based shall be treated as out21 standing stock in such corporation and deemed22 owned shares of such person if such treatment of

23 synthetic equity of 1 or more such persons results

24 in—
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1 ‘‘(A) the treatment of any person as a dis2 qualified person, or

3 ‘‘(B) the treatment of any year as a non4 allocation year.

5 For purposes of this paragraph, synthetic equity

6 shall be treated as owned by a person in the same

7 manner as stock is treated as owned by a person

8 under the rules of paragraphs (2) and (3) of section

9 318(a).

10 ‘‘(6) DEFINITIONS.—For purposes of this

11 subsection—

12 ‘‘(A) EMPLOYEE STOCK OWNERSHIP

13 PLAN.—The term ‘employee stock ownership

14 plan’ has the meaning given such term by sec15 tion 4975(e)(7).

16 ‘‘(B) EMPLOYER SECURITIES.—The term

17 ‘employer security’ has the meaning given such

18 term by section 409(l).

19 ‘‘(C) SYNTHETIC EQUITY.—The term ‘syn20 thetic equity’ means any stock option, warrant,

21 restricted stock, deferred issuance stock right,

22 or similar interest or right that gives the holder

23 the right to acquire or receive stock of the S

24 corporation in the future. Except to the extent

25 provided in regulations, synthetic equity also in-
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1 cludes a stock appreciation right, phantom

2 stock unit, or similar right to a future cash

3 payment based on the value of such stock or

4 appreciation in such value.

5 ‘‘(7) REGULATIONS.—The Secretary shall pre6 scribe such regulations as may be necessary to carry

7 out the purposes of this subsection.’’

8 (b) COORDINATION WITH SECTION 4975(e)(7).—The

9 last sentence of section 4975(e)(7) of such Code (defining

10 employee stock ownership plan) is amended by inserting

11 ‘‘, section 409(p),’’ after ‘‘409(n)’’.

12 (c) EXCISE TAX.—

13 (1) APPLICATION OF TAX.—Subsection (a) of

14 section 4979A of such Code (relating to tax on cer15 tain prohibited allocations of employer securities) is

16 amended—

17 (A) by striking ‘‘or’’ at the end of para18 graph (1),

19 (B) by striking the period at the end of

20 paragraph (2) and inserting a comma, and

21 (C) by striking all that follows paragraph

22 (2) and inserting the following:

23 ‘‘(3) there is any allocation of employer securi24 ties which violates the provisions of section 409(p),

25 or
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1 ‘‘(4) any synthetic equity is owned by a dis2 qualified person in any nonallocation year,

3 there is hereby imposed a tax on such allocation or owner4 ship equal to 50 percent of the amount involved.’’

5 (2) LIABILITY.—Section 4979A(c) of such Code

6 (defining liability for tax) is amended to read as fol7 lows:

8 ‘‘(c) LIABILITY FOR TAX.—The tax imposed by this

9 section shall be paid—

10 ‘‘(1) in the case of an allocation referred to in

11 paragraph (1) or (2) of subsection (a), by—

12 ‘‘(A) the employer sponsoring such plan, or

13 ‘‘(B) the eligible worker-owned cooperative,

14 which made the written statement described in sec15 tion 664(g)(1)(E) or in section 1042(b)(3)(B) (as

16 the case may be), and

17 ‘‘(2) in the case of an allocation or ownership

18 referred to in paragraph (3) or (4) of subsection (a),

19 by the S corporation the stock in which was so allo20 cated or owned.’’

21 (3) DEFINITIONS.—Section 4979A(e) of such

22 Code (relating to definitions) is amended to read as

23 follows:

24 ‘‘(e) DEFINITIONS AND SPECIAL RULES.—For pur25 poses of this section—
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1 ‘‘(1) DEFINITIONS.—Except as provided in

2 paragraph (2), terms used in this section have the

3 same respective meanings as when used in sections

4 409 and 4978.

5 ‘‘(2) SPECIAL RULES RELATING TO TAX IM6 POSED BY REASON OF PARAGRAPH (3) OR (4) OF

7 SUBSECTION (a).—

8 ‘‘(A) PROHIBITED ALLOCATIONS.—The

9 amount involved with respect to any tax im10 posed by reason of subsection (a)(3) is the

11 amount allocated to the account of any person

12 in violation of section 408(p)(1).

13 ‘‘(B) SYNTHETIC EQUITY.—The amount

14 involved with respect to any tax imposed by rea15 son of subsection (a)(4) is the value of the

16 shares on which the synthetic equity is based.

17 ‘‘(C) SPECIAL RULE FOR PROHIBITED AL18 LOCATION DURING FIRST NONALLOCATION

19 YEAR.—For purposes of subparagraph (A), the

20 amount involved for the first nonallocation year

21 of any employee stock ownership plan shall be

22 determined by taking into account the total

23 value of all the deemed-owned shares of all dis24 qualified persons with respect to such plan.
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1 ‘‘(D) STATUTE OF LIMITATIONS.—The

2 statutory period for the assessment of any tax

3 imposed by this section by reason of paragraph

4 (3) or (4) of subsection (a) shall not expire be5 fore the date which is 3 years from the later

6 of—

7 ‘‘(i) the allocation or ownership re8 ferred to in such paragraph giving rise to

9 such tax, or

10 ‘‘(ii) the date on which the Secretary

11 is notified of such allocation or owner12 ship.’’

13 (d) EFFECTIVE DATES.—

14 (1) IN GENERAL.—The amendments made by

15 this section shall apply to plan years beginning after

16 December 31, 2000.

17 (2) EXCEPTION FOR CERTAIN PLANS.—In the

18 case of any—

19 (A) employee stock ownership plan estab20 lished after July 14, 1999, or

21 (B) employee stock ownership plan estab22 lished on or before such date if employer securi23 ties held by the plan consist of stock in a cor24 poration with respect to which an election under
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1 section 1362(a) of the Internal Revenue Code

2 of 1986 is not in effect on such date,

3 the amendments made by this section shall apply to

4 plan years ending after July 14, 1999.

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