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New Iowa ESOP break clears House committee

February 02, 2012

The Governor's proposed new break for ESOPs moved closer to passage yesterday when it cleared the House Ways and Means Committee. Like too many bad bills, it passed unanimously.

The bill, HF 2085, provides an exclusion on sales of stock to Employee Stock Ownership Plans if the corporation owns at least 30% of the company's stock after the transaction.

The key language of the bill:

(1) To the extent not already excluded, the net capital gain from the sale or exchange of employer securities of an Iowa corporation to a qualified Iowa employee stock ownership plan when, upon completion of the transaction, the qualified Iowa employee stock ownership plan owns at least thirty percent of all outstanding employer securities issued by the Iowa corporation.

(2) For purposes of this paragraph:

(a) "Employer securities" means the same as defined in 1 section 409(l) of the Internal Revenue Code.

(b) "Iowa corporation" means a corporation whose commercial 3 domicile, as defined in section 422.32, is in this state.

Even if you think extra state breaks for ESOPs are a great idea (they aren't), this bill is a mess. It meshes badly with Federal Code Section 1042, which provides an elective deferral for sales to ESOPs owning 30% of the corporation stock if the proceeds are re-invested in public securities. The gain is deferred until the public securities are sold.

The way this bill is written, it may make people selling stock to ESOPs choose between a federal deferral of taxable income and a permanent state exclusion. Remember, the Iowa break only applies on a sale of "employer securities." The securities purchased when proceeds are re-invested under Section 1042 are not "employer securities," so the Iowa break will not apply when they are eventually sold. If language excluding the deferred Section 1042 gain is added to the bill (Iowa gain is normally the same as federal), it would require taxpayers taking advantage of the federal break to remember to reduce the gain on the eventual sale of the rollover securities for their Iowa returns.

So why are state ESOP breaks not a good idea? The ESOP rules are incredibly complicated, and for many closely-held S corporations, almost hopelessly so. A state break adds an additional layer of complexity to an already byzantine part of the tax law. It also makes the Iowa tax law even more complicated. It will do about as much good for the Iowa economy as a bill signed yesterday "RELATING TO FINANCIAL ASSISTANCE FOR PURPOSES OF THE BATTLESHIP IOWA."

We shouldn't be adding more small-beer tax breaks to an Iowa tax law already full of them. Like the Battleship Iowa, the Iowa income tax is obsolete. It's time to start over with a simple system with low rates -- something like the Quick and Dirty Iowa Tax Reform plan. Unlike this break, it could actually more than a token difference for the Iowa economy.

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Joe, thanks for the stirring shot of the USS Iowa. Like the 1939 Code, they just don't make 'em that way any more.

Jake - glad you enjoyed. Thank Wikipedia Commons for the picture.

I know, battleships and steam engines have had their day, but they will always be amazing and cool. I hope to be able to tour the Iowa someday.

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