To amend the Internal Revenue Code of 1986 to improve the operation of employee stock ownership plans, and for other purposes.

June 28, 2005

Mrs. LINCOLN introduced the following bill; which was read twice and referred to the Committee on Finance

To amend the Internal Revenue Code of 1986 to improve the operation of employee stock ownership plans, and for other purposes.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE.

This Act may be cited as the `Employee Stock Ownership Plan Promotion and Improvement Act of 2005'.

SEC. 2. 10 PERCENT PENALTY TAX NOT TO APPLY TO CERTAIN S CORPORATION DISTRIBUTIONS MADE ON STOCK HELD BY EMPLOYEE STOCK OWNERSHIP PLAN.

(a) In General- Clause (vi) of section 72(t)(2)(A) of the Internal Revenue Code of 1986 (relating to general rule that subsection not to apply to certain distributions) is amended by inserting before the comma at the end the following: `or any distribution (as described in section 1368(a)) with respect to S corporation stock that constitutes qualifying employer securities (as defined by section 409(l)) to the extent that such distributions are paid to a participant in the manner described in clause (i) or (ii) of section 404(k)(2)(A)'.

(b) Effective Date- The amendments made by this section shall apply to distributions made after the date of the enactment of this Act.

SEC. 3. ESOP DIVIDEND EXCEPTION TO ADJUSTMENTS BASED ON ADJUSTED CURRENT EARNINGS.

(a) In General- Section 56(g)(4)(C) of the Internal Revenue Code of 1986 (relating to disallowance of items not deductible in computing earnings and profits) is amended by adding at the end the following new clause:

`(v) TREATMENT OF ESOP DIVIDENDS- Clause (i) shall not apply to any deduction allowable under section 404(k) if the deduction is allowed for dividends paid on employer securities held by an employee stock ownership plan established or authorized to be established before March 15, 1991.'.

(b) Effective Date- The amendment made by this section shall apply to taxable years beginning after December 31, 1989.

(c) Waiver of Limitations- If refund or credit of any overpayment of tax resulting from the application of the amendment made by this section is prevented at any time before the close of the 1-year period beginning on the date of the enactment of this Act by the operation of any law or rule of law (including res judicata), such refund or credit may nevertheless be made or allowed if claim therefor is filed before the close of such period.

SEC. 4. AMENDMENTS RELATED TO SECTION 1042.

(a) Deferral of Tax for Certain Sales to Employee Stock Ownership Plan Sponsored by S Corporation-

(1) IN GENERAL- Section 1042(c)(1)(A) of the Internal Revenue Code of 1986 (defining qualified securities) is amended by striking `C'.

(2) EFFECTIVE DATE- The amendment made by paragraph (1) shall apply to sales after the date of the enactment of this Act.

(b) Reinvestment in Certain Mutual Funds Permitted-

(1) IN GENERAL- Clause (ii) of section 1042(c)(4)(B) of the Internal Revenue Code of 1986 (defining operating corporation) is amended to read as follows:

`(ii) FINANCIAL INSTITUTIONS, INSURANCE COMPANIES, AND MUTUAL FUNDS- The term `operating corporation' shall include--

`(I) any financial institution described in section 581,

`(II) any insurance company subject to tax under subchapter L, and

`(III) any regulated investment company if substantially all of the securities held by such company are securities issued by operating corporations (determined without regard to this subclause).'.

(2) EFFECTIVE DATE- The amendment made by paragraph (1) shall apply to sales of qualified securities after the date of the enactment of this Act.

(c) Modification to 25-Percent Shareholder Rule-

(1) IN GENERAL- Subparagraph (B) of section 409(n)(1) of the Internal Revenue Code of 1986 (relating to securities received in certain transactions) is amended to read as follows:

`(B) for the benefit of any other person who owns (after the application of section 318(a)) more than 25 percent of--

`(i) the total combined voting power of all classes of stock of the corporation which issued such employer securities or of any corporation which is a member of the same controlled group of corporations (within the meaning of subsection (l)(4)) as such corporation, or

`(ii) the total value of all classes of stock of any such corporation.'.

(2) EFFECTIVE DATE- The amendment made by paragraph (1) shall take effect on the date of the enactment of this Act.

SEC. 5. EARLY DISTRIBUTIONS FROM EMPLOYEE STOCK OWNERSHIP PLANS FOR HIGHER EDUCATION EXPENSES AND FIRST-TIME HOMEBUYER PURCHASES.

(a) In General- Paragraph (2) of section 72(t) of the Internal Revenue Code of 1986 (relating to 10-percent additional tax on early distributions from qualified retirement plans) is amended by adding at the end the following new subparagraph:

`(G) DISTRIBUTIONS FROM EMPLOYEE STOCK OWNERSHIP PLANS FOR HIGHER EDUCATION EXPENSES AND FIRST-TIME HOMEBUYER PURCHASES-

`(i) IN GENERAL- Distributions made to the employee from an employee stock ownership plan (within the meaning of section 4975(e)(7)), the amount of which does not exceed the sum of--

`(I) qualified higher education expenses (as defined by paragraph (7)) reduced by the amount of such expenses taken into account under subparagraph (E), and

`(II) qualified first-time homebuyer distributions (as defined by paragraph (8)) reduced by the amount of such distributions taken into account under subparagraph (F).

`(ii) LIMITATION- A distribution may only be taken into account under clause (i) if--

`(I) such distribution is in the form of either employer securities (within the meaning of section 409(l)) or cash proceeds resulting from the sale of such securities made not more than 180 days before the date of such distribution for the purposes of such distribution,

`(II) such securities so distributed or sold were held by such plan for at least 5 years before the date of such distribution or, if applicable, sale, and

`(III) the number of shares in each class of such securities so distributed or sold, when added to all previous distributions and sales of each such class of such securities for such purposes on behalf of such employee, does not exceed 10 percent of the aggregate number of shares of each class of such securities allocated to the account of such employee under such plan.

`(iii) VALUATION OF DISTRIBUTED SECURITIES- For purposes of clause (ii), the value of a security shall be the value of such security on the date of distribution.'.

(b) Conforming Amendments-

(1) Paragraph (7) of section 72(t) of such Code is amended by striking `paragraph (2)(E)' and inserting `subparagraphs (E) and (G) of paragraph (2)'.

(2) Paragraph (8) of section 72(t) of such Code is amended by striking `paragraph (2)(F)' and inserting `subparagraphs (F) and (G) of paragraph (2)'.

(c) Effective Date- The amendments made by this section shall apply to distributions made after the date of the enactment of this Act.

SEC. 6. DE MINIMIS EXCEPTION TO DIVERSIFICATION OF INVESTMENT REQUIREMENT.

(a) In General- Paragraph (28) of section 401(a) of the Internal Revenue Code of 1986 (relating to additional requirements relating to employee stock ownership plans) is amended by adding at the end the following new subparagraph:

`(D) EXCEPTION FOR DE MINIMIS ACCOUNT BALANCE- A plan shall not fail to meet the requirements of this subparagraph for a plan year solely because the plan provides that clause (i) does not apply to any participant's account in the plan which, as of the close of the preceding plan year, has an account balance which does not exceed $2,500.'.

(b) Effective Date- The amendment made by this section shall apply to plan years beginning after the date of the enactment of this Act.

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