Lawmaker Urges Use of ESOPs for Companies in O-Zones

PUBLIC SUBMISSION

Docket: IRS-2018-0029
Investing in Qualified Opportunity Funds (REG-115420-18)

Comment On: IRS-2018-0029-0001
Investing in Qualified Opportunity Funds (REG-115420-18)

Document: IRS-2018-0029-0047
Investing in Qualified Opportunity Funds (REG-115420-18)

Submitter Information

Name: Rep-Elect Jesus Chuy Garcia

Address:

Email: don.andres@mail.house.gov

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General Comment

December 20, 2018

Honorable Steven Mnuchin
Secretary of the Treasury
Washington, DC

Dear Mr. Secretary:

I write to recommend added flexibility in the regulations regarding Qualified Opportunity Zones (REG-115420-18) issued on October 19, 2018. I would like to suggest the inclusion of language that would encourage the use of Employee Stock Ownership Plans (ESOP) for private companies operating within these zones. Such an inclusion would enable equity participation in addition to wages for workers and managers of those companies.

As a member of the Cook County Board of Commissioners, I chaired the Commission on Social Innovation which supported initiatives to promote the transfer of ownership of businesses to their employees via Employee Stock Ownership Plans. Such transfers incentivize key community businesses to remain in their communities, grow the wealth of their employees and provide employment opportunities for area residents.

The State of Illinois has designated several tracts within Illinois 4th Congressional district as opportunity zones. It is absolutely critical that these selected communities and their residents, for whom such designations seek to uplift, remain the primary beneficiaries of the long-term economic growth spurred by these designations. Expanding ESOP investments in Qualified Opportunity Zones is a proven and effective mechanism to ensure communities and long-time residents remain the focal point of new economic development encouraged by these opportunity zone designations.

The specific proposed revision to Qualified Opportunity Zone regulations would make it easier to create ESOPs in such zones by allowing the ESOP to be designed using structured equity.

To that end, I propose the following change to Code section 1400Z-2 of the new proposed regulations:

Add to the definition of qualified opportunity zone stock in 1.1400Z-2(d)-1(c)(2) a provision that the term qualified opportunity zone stock includes any interest constituting synthetic equity within the meaning of section 409(p)(6)(C) and the regulations thereunder, in the case of an S corporation the stock of which is owned by an employee stock ownership plan (ESOP), as defined in section 4975(e)(7).

The full tax benefits of an ESOP are available only if all of the stock of an S corporation is held by the ESOP. Accordingly, outside investors in ESOP-owned S corporations typically acquire their equity by investing in hybrid securities of the S corporation which do not fall within the meaning of stock under section 1361. Such securities include convertible debt and subordinated debt with warrants attached, among others. This issue was confronted by Congress in enacting the ESOP anti-abuse provision of section 409(p), which creates the concept of synthetic equity to describe the hybrid securities representing this kind of non-stock equity. The concept is equally applicable here, to ensure that the purpose of the opportunity zone tax provisions is carried out by enabling the use of ESOPs in appropriate situations.

I am aware that the city of Newark, New Jersey has made a similar submission on this topic of ESOPs and Opportunity Zones, and I am glad to join them in promoting this policy objective.

Thank you for your consideration.

Sincerely,

Jess Chuy Garca
Representative-elect
Illinois 4th Congressional District