How The Inflation Reduction Act Impacts ESOPs

The simple fact is that ESOPs are here to stay as an effective and powerful business succession strategy. This isn’t merely wishful thinking from a firm of strong ESOP believers, it’s evident by the encouragement that Congress keeps showing. Take the pilot program created by Section 874 of the National Defense Authorisiation Act (“NDAA”) which was signed into law by President Biden on December 27th, 2021. 

This program enables companies which are already (or are becoming) qualified businesses that are wholly-owned through an employee stock ownership plan (ESOP), and which bid on contracts procured by the United States Department of Defense to qualify to bid on “follow-on contracts” – all without the hassle of going through a fiercely competitive bidding process. 

Look, there are no doubt several limitations to this statute. For example, there is a restriction that would prevent sub-contracting over 50% of the value of the contract. This way, if any of these businesses rely on sub-contractors, they will be in a position where they have to change their practices.

What this tells us, though, is that Congress has established the first-ever government contracting program to specifically encourage ESOPs. Additionally, in three years time the Comptroller General will need to submit a report to Congress – a report that will extend this pilot program. The light at the end of restricted tunnel is that these limitations may change at some point.

But this legislature is a great side note but not the main event. 

What we want to focus on is how ESOPs have scored a major win through the newly introduced Inflation Reduction Act.

To help you gain a better understanding of this Act and familiarize yourself with the updated legislature and how it impacts ESOP plans, we have gone through the salient points and unpacked them in this article. 

What is The Inflation Reduction Act?

This month, on August 16th, 2022, President Biden signed the Inflation Reduction Act (IRA or ‘the Act’) into law. 

We don’t want to go into the heavy details surrounding the provisions laid out in the IRA, but we will do our best to give you the key takeaways. Starting with the fact that the IRA is an attempt to combat climate change and rising consumer healthcare costs, while simultaneously reducing the deficit.

Additionally, topline estimates include that a $737 billion in total revenue will be raised, $437 billion in total investments, and over $300 billion in total will be realised through deficit reduction. There are also investing implications across multiple sectors, including healthcare, energy, and technology.

Described as a ‘far-ranging law’ by some, what we have seen that is of particular interest to us as a national ESOP firm are the tax implications. That’s why we’re starting with a little overview on what the Act means insofar as taxes for businesses is concerned.

How The Act Impacts Taxes

From a taxation perspective, the IRA intends to impose a new alternative minimum 15% corporate tax rate for companies. This is effective for tax years beginning after December 31, 2022. 

Wondering if this applies to you? To put it as simply as possible, the new tax applies to the adjusted financial statements of income of US corporations with a three-year average adjusted book income of over $1 billion. It also applies to foreign corporations with an average US income of over $100 million. Lastly, these tax implications mean that there will be a 1% tax imposed on stock buybacks net of new issuances of stock, effective for repurchases after December 31, 2022. 

According to our research, it would appear that the Joint Committee on Taxation has revealed that about 150 of the largest US corporations would be subject to the new corporate minimum tax. And all of those companies who would be subject to the 1% tax on stock buybacks, will be affected on January 1, 2023. 

Now, here’s where it gets interesting. Stocks contributed to retirement accounts, pensions, and employee-stock ownership plans (ESOPs) are exempt from taxation. 

While we’re not convinced that the new tax on share buybacks will have a noticeable investing impact from a shareholder perspective, we do think that there will undoubtedly be an increase in buyback activity before then to get out ahead of these new tax implications.

As an aside, it’s worth mentioning that to our minds, the introduction of the new tax laws is yet another way in which Congress is encouraging the establishment of increasingly more ESOPs.

What The Act Means For ESOPs // How The Bill Affects ESOPs

No doubt it has occurred to you that the tax on stock repurchases is quite the revenue raiser for the Inflation Reduction Act. 

However, stock repurchase is vital to the function and success of an ESOP. To that end, the ESOP Association has worked diligently and tirelessly for well over a year to ensure that an exemption from this new excise tax for stock being purchased by ESOPs is written into the final law.

What this exemption does is protect existing ESOPs that may engage in future stock purchases or repurchases through their ESOP. Utilizing an ESOP for future stock repurchases could therefore serve as a win-win for the company and the employees who would benefit from the ownership. Not to mention the increase in share value through repurchase. 

However, it must be acknowledged that the exemption also has the potential to create a new incentive for employee ownership and shared capitalism. Essentially, publicly traded companies seeking to repurchase shares can avoid the excise tax by doing that transaction through an ESOP – a huge advantage.

Ultimately, the hope is that companies engaging in stock repurchases will view the formation of an ESOP to benefit their employees as an opportunity. And we have TEA to thank for this, whose members who have participated in advocacy efforts with their federal elected officials over the past few years. Really, it’s thanks to the strength of their efforts to educate members of Congress on the critical importance of ESOPs that this has been made possible.

What Is TEA?

The ESOP Association, or TEA, is the largest organization in the world, with headquarters at the International Employee Ownership Center in Washington, DC. It operates as a 501(c)6 organization with the affiliated Employee Ownership Foundation and aims to support three main groups. These groups include employee-owned companies, the over 10 million U.S. employees who participate in ESOPs, and the many professionals who provide services to them. 

Essentially, the support provided by TEA is evident in the way that it conducts and funds academic research, it provides more than 160 annual conferences and events attended by nearly 15,000 individuals, and it advocates on behalf of employee owners and their businesses to federal and state lawmakers.

TEA has commended both the House and Senate for including provisions that will exempt ESOPs from new excise taxes on stock repurchases. What we think is important to take note of is how TEA has also worked with Congress to curb the use of stock repurchases as a tax avoidance strategy – because clearly the last thing that anyone wants is to adversely impact ESOPs or their future formation!  

At Excel Legacy Group, we would like to thank TEA for their dedication and vigilant efforts, and we would also like to join TEA President and CEO Jim Bonham in applauding the leaders in Congress for recognizing the importance of employee ownership and including provisions to support the future growth of ESOPs.

Let Excel Legacy Group Help 

We truly hope that this information proves useful and answers your questions regarding the new legislation and how the various tax provisions will affect your ESOP, the employees, and of course, your company. 

That said, if you find that you need more information, then we urge you to consult with our team of well-versed professionals who are equipped to walk you through any questions you have regarding ESOPs and the new legislation.

Talk to the Excel Legacy Group today.