Steve Eide, Partner, Saul Ewing Arstein Lehr LLP April 15, 2020
On March 9, 2020, a bill designed to stimulate the creation of employee-owned businesses and ultimately preserve jobs in Minnesota was introduced in the Minnesota Senate and referred to the Senate Taxes Committee.
The bill, S.F. No. 4161, would provide two types of tax incentives to encourage small business owners to transfer equity to an ESOP or worker cooperative. One incentive is a subtraction from Minnesota income for capital gains realized by an owner when the business is sold to employees.
The other tax break would allow sellers who help to finance the purchase of their stock to exclude the interest payments from their Minnesota taxable income. The interest income subtraction also applies to certain commercial lenders, including banks and insurance companies. The aim of this provision is to reduce the cost of financing the change in ownership, leaving the employee-owned company with more cash as the debt is paid off – cash that can be used to expand the business and create more jobs.
The pending legislation is the result of efforts by the Minnesota/Dakotas Chapter of The ESOP Association. A group led by Steve Eide of the Saul Ewing Arnstein & Lehr law firm generated support among several key members of the Senate Taxes Committee and worked with non- partisan Senate staff to prepare a draft of the bill. Other volunteers who are participating in the lobbying efforts are Theresa Ferret of Toll Company, a 100% ESOP company based in Plymouth, and Jim Vogl of the Fredrikson & Byron law firm.
The bill was introduced in the Minnesota Senate by Sen. Roger Chamberlain, the Republican Chairman of the Taxes Committee and by Sen. Ann Rest, the ranking DFL member of the Committee. With the endorsement of the committee leadership from both parties, supporters of the bill were optimistic about the bill becoming law.
A first hearing for the bill was scheduled for March 17, but the Committee meeting was cancelled due to coronavirus concerns. The outlook for passage in the current legislative session is now uncertain as the pandemic has dramatically shifted the state government’s priorities and impeded the lawmakers’ ability to make law. The legislature is constitutionally required to wrap up its work by May 18, 2020.
So, you ask, how exactly would the tax incentives work if they become law?
Unlike federal law, which provides no tax incentives for owners of S corporations, S.F. No. 4161 would apply to ownership transitions of both S corporations and C corporations – provided that they are considered “eligible Minnesota corporations” under the new law.
To be eligible under the bill as introduced in the Senate, a company can have no more than 500 employees. It must either have its principal place of business in Minnesota or meet a minimum threshold for providing equity to Minnesota workers. In an ESOP transaction, at least 20 Minnesota residents must meet the requirements for participating in the ESOP if the company is not based in Minnesota. An out-of-state corporation becoming a worker cooperative qualifies as an eligible Minnesota corporation if at least five Minnesota residents are eligible to purchase membership in the cooperative.
Business owners will find that qualifying for the capital gain subtraction is simpler than claiming the somewhat analogous tax deferral for sales of C corporation stock under federal Section 1042. The federal provision requires the reinvestment of proceeds in U.S. stocks or corporate bonds, and the deferred gain becomes taxable as the selling shareholder divests the replacement stocks and bonds. In contrast, the Minnesota law would not place any restrictions on what the seller does with the sale proceeds. And the subtraction would permanently exempt the capital gain from Minnesota taxes; this is more than a deferral of taxation.
Like Section 1042, S.F. No. 4161 requires sellers to have held the stock for at least three years prior to the sale, and the ESOP or worker cooperative must own at least 30% of the equity after the sale closes. The same 30% minimum ownership requirement must be satisfied to qualify for the interest exclusion.
The bill is designed to provide flexibility in how an ownership succession transaction is structured, as long as it achieves the desired result. It is expected that even more flexibility will be built into the statutory language before the legislation is finalized.
For example, a loan can qualify for the interest subtraction if credit is extended to an ESOP trustee to allow the purchase of stock, but it can also qualify if the small business borrows the money and lends the proceeds to the ESOP trustee. For conversions to worker cooperatives, the interest exclusion would be available for loans to the business that are used to redeem the owner’s shares.
We Are Not Alone
By enacting this legislation, Minnesota would be joining a growing list of states that are promoting employee ownership as a means of preserving jobs and strengthening their economies. States that have already adopted measures include Iowa, Nebraska, Missouri, Colorado and Massachusetts, and bills have been introduced in a number of other states.
The available tools for spurring employee ownership are not limited to tax incentives. State legislatures also employ outreach and education programs, grant money for companies exploring the feasibility of an ESOP or cooperative, and preferences for ESOP-owned companies
in awarding state and local contracts. The common denominator is that states across the country are beginning to appreciate the same economic and social benefits that led to the creation of the Minnesota Center for Employee Ownership – retaining businesses as their owners retire, growing jobs, addressing wage and wealth gaps, and strengthening communities.
For further information about S.F. No. 4161 and how you can help to make it law, contact Steve Eide at 612-225-2955 or firstname.lastname@example.org.