University of Pennsylvania Paper Finds S Corporation ESOPs Help Employees, Employers, and Taxpayers

In "S Corp ESOP Legislation Benefits and Costs: Public Policy and Tax Analysis," Steven Freeman and Michael Knoll of the University of Pennsylvania conclude that S corporation ESOPs add an annual $14 billion in additional compensation that would not have been paid absent an ESOP, lead to annual job stability gains worth another $3 billion, and provide an additional $34 billion in annual increases in account values from stock gains in the accounts held by participants. Employers pay for this out of firm-level performance gains of $33 billion per year. The increased performance of ESOP companies, plus the fact that foregone taxes on earnings are ultimately paid by employees when they start to take benefits out some time after termination, mean that S ESOPs are a net gain for taxpayers. In addition, when employees do pay tax on their distributions, they pay on the basis of (generally) appreciated stock, with part of that appreciation due to the company's ability not to pay taxes in the interim. Given assumptions about their tax rates, the authors conclude that, on balance, the Treasury is likely to end up with more revenue this way than if the income was taxed earlier. The paper is published by the University of Pennsylvania Center for Organizational Dynamics (Working Paper #08-07).