The Internal Revenue Service (IRS) is intensifying its scrutiny of employee stock-ownership plans (ESOPs) as it cracks down on businesses trying to evade their tax responsibilities.
Understanding ESOPs
ESOPs are retirement plans that primarily invest in a company’s stocks. Similar to a 401(k), these plans allow the holdings to grow tax-deferred for employees until distribution. It is important to note that ESOPs differ from employee stock-option plans, which grant employees the right, but not the obligation, to purchase company stocks at a predetermined price after a specific period.
Benefits and Purpose
While ESOPs can be used for succession planning, enabling business owners to transfer their shares to employees, they also foster productivity and enhance employee retention by offering workers a vested interest in the company’s success.
IRS Warning and Enforcement Focus
However, the IRS released a cautionary statement this week, revealing concerns about certain businesses potentially exploiting the complex rules surrounding ESOPs. The agency vowed to remain vigilant and enforce compliance with greater rigor, especially among businesses and high-net worth individuals following funding from last year’s Inflation Reduction Act.
Emerging Issues
One issue identified by the IRS is the misuse of loans within ESOPs for purchasing shares. Additionally, there are questions surrounding the valuation of stocks within private businesses utilizing these ownership plans. According to regulations, the stock must undergo annual appraisal. The IRS suspects that some tax structures associated with ESOPs might be diverting business income that should be subject to taxation.
As the IRS tightens its grip on ESOPs, businesses and individuals engaging in these plans should prepare for increased scrutiny and ensure strict adherence to the tax regulations surrounding these arrangements.
Closing the Gap: Employee Stock Ownership Plans Under Scrutiny
The IRS is taking steps to close the gap between taxes owed and taxes paid, and that includes focusing on higher-income taxpayers and businesses involved in complex or questionable transactions, such as those related to employee stock ownership plans (ESOPs), according to IRS Commissioner Danny Werfel.
ESOPs have been widely adopted by employers, with over 6,400 companies offering these plans through 2020. These plans cover a staggering 13.9 million individuals and hold more than $300 billion in company stock, as per data from the Labor Department cited by the National Center for Employee Ownership (NCEO).
NCEO, a nonprofit organization focused on researching worker ownership and guiding businesses interested in staff ownership, has emphasized that ESOPs are just one part of a larger picture. The number of traditional 401(k) plans far surpasses that of ESOPs, with employers offering approximately 600,000 401(k) plans in 2020, covering a substantial 60 million workers, as reported by the Investment Company Institute.
However, concerns have been raised about the broad approach taken by the IRS. Loren Rodgers, executive director of NCEO, argues that the IRS is painting with too broad a brush when it comes to ESOPs. While acknowledging that some plans may indeed violate tax rules, Rodgers asserts that the overall impact of these plans is overwhelmingly positive.
In fact, NCEO’s 2017 study, which analyzed Bureau of Labor Statistics data for workers aged 28 to 34, found that younger workers participating in ESOPs experience significantly higher household wealth and wage income compared to their counterparts who do not participate in such plans.
Nevertheless, Rodgers cautions that increased scrutiny from the IRS may discourage law-abiding businesses from implementing ESOPs due to the potential hassles involved. There is a concern that the IRS runs the risk of triggering an overreaction if it fails to strike the right balance between enforcement and supporting the benefits of ESOPs.
In conclusion, as the IRS intensifies its efforts to ensure tax compliance, particularly among higher-income taxpayers and businesses, it is important to carefully evaluate the impact of these measures on employee stock ownership plans. While caution is necessary, it is crucial not to undermine the positive contributions of ESOPs to workers’ wealth and income.
