Internationally, the most significant short-term vehicle for democratic employee ownership is the transfer of existing businesses (CECOP 2012). This strategy is viewed as important for retaining quality jobs and entrepreneurial capital. In addition, successful business transfers create stronger opportunities for job growth than start-ups. Challenges include the lack of knowledge about business transfers among professionals, such as lawyers, accountants, and estate managers. Opportunities include the ability to leverage existing federal tax benefits, such as the IRC § 1042 “rollover” of capital gains tax. We recommend the following policies, in order of importance:
As a top priority, we urge states to adopt an “Employee Ownership Assistance” loan program on New York State's model under Subtitle VI of the New York Job Development Authority Act. Originally passed during Governor Mario Cuomo’s first term, the New York statute provides up to 40% in direct financing for employee ownership projects, as well as 80% loan guarantees for participating banks. N.Y. Pub. Auth. Law § 1836-e(2). In economically distressed areas, the law provides up to 60% in direct financing. N.Y. Pub. Auth. Law § 1823(7)(a). In particular, the law provides for loans from local development corporations to intermediary organizations for the purpose of transitioning existing businesses into employee-owned enterprises. Importantly, New York State maintains a broad definition of "employee-owned enterprises" as any "business in which the employees are represented on the board of directors and the employees control the majority of the voting stock, or if the business is held in a trust which controls the majority of the voting stock, the trustees are elected by the employees." N.Y. Pub. Auth. Law § 1836-b(5). At the ICA Group, we believe that a critical step in the future direction of employee ownership involves moving away from a binary selection of an ESOP (which is prohibitively expensive for most firms) and a worker cooperative (which is often prohibitively inflexible for most sellers). Likewise, even New York State's definition could expand to include employee ownership plans that include a minority of voting stock, while retaining other features of the definition.
As a secondary priority, the proposed 100% capital gains tax exemption would leverage existing federal tax benefits for the transfer of a business to an employee-owned enterprise. In short, a business owner who transfers a portion of a firm’s voting shares to democratic employee ownership qualifies for 100% exemption of state capital gains taxes. With a companion 100% capital gains tax exemption for New York City, NYC-based businesses could receive the maximum benefit available in the United States—at a combined city and state capital gains tax of approximately 14%.
In many cases, owners would still have the option of “rolling over” the remaining sale proceeds to defer 100% of the federal capital gains tax. Federal tax law permits a deferral of 100% of federal capital gains taxes—which becomes a permanent exemption where the seller defers for the remainder of their lifetime. This strategy is viewed as important for retaining quality jobs and entrepreneurial capital. In addition, successful business transfers create stronger opportunities for job growth than start-ups.
This state law rule also has precedent in the 2012 Iowa Acts House File 2465 “Capital Gain Deduction for Sale of Stock to an Iowa ESOP” which exempts a portion of sale proceeds from sale to an ESOP. The New Jersey legislature is considering a similar bill as proposed by Rutgers University Professors Joseph Blasi and Douglas Kruse. NJ Assembly Bill 2911 would also exempt 100% of capital gains taxes on sale proceeds (NCEO 2014).
International bodies such as CECOP (2012) and the International Cooperative Alliance recognize the need for untaxed retained earnings that exist for the benefit of the firm, its workers, and the broader community. As currently instituted in Germany, France, Italy, Spain, and Quebec, tax-exempt reserves act to promote reinvestment in democratic firms to grow jobs and stabilize income (Reynolds 2013). The proposed exemption would apply to corporate tax on:
a) earnings retained by employee-owned enterprises; and
b) earnings attributable to any portion of company stock under democratic employee ownership, either directly through employee membership shares or indirectly through a democratic employee trust. The exemption would also apply to income tax owed by a democratic employee trust where the firm is treated as a partnership.
This benefit would build on existing federal tax policy under IRC § 521 that exempts worker cooperative firms from taxation on worker-member profits or “patronage” and restore tax-exempt reserves for worker cooperatives that existed prior to 1951 (Magill 1959). Importantly, it would mirror federal tax policy under IRC § 512 that exempts S-Corp ESOPs from taxation on retained earnings attributable to the ESOP.
Incentivize the support of lending institutions by excluding interest income received on any loan financing for the conversion of an existing entity into an employee-owned enterprise, or for the transfer of any portion of company stock to democratic employee ownership, either held directly through employee membership shares or indirectly through a democratic employee trust.
Expand NY Tax Law § 999-A, § 2055(a)(5) to qualify bequests to employee-owned enterprises––or to democratic employee ownership, either held directly through employee membership shares or indirectly through a democratic employee trust––as charitable (i.e., deductible) in calculating a decedent’s taxable estate.
NY Education Law § 3032(4)(a) provides “training to individuals to promote the successful management and/or operation of a business purchased by such individuals to provide for their continued employment through the formation of a worker owned cooperative or a democratic employee trust. No grant shall exceed fifty per centum of the total program cost. Eligible program cost may include employer wages paid to the employee for time spent in the training program.” The State of New York could reauthorize these funds in the state’s annual budget. Additionally, the training grant program would expand to include employee-owned enterprises not resulting from business transfers.
NYS should allocate funding for the existing NY Economic Development Law § 104-a, which provides resources for a Center for Democratic Employee Ownership that would promote awareness of business transfers among employers—and provide support to professionals engaged in estate management. This center would professionally market the availability of federal and state capital gains exclusions available to selling and/or retiring business owners. If additional funding were made available, the center would offer “matching grants” to employers for accounting, legal, and business planning expenses related to the sale, as in Iowa. Center staff would provide professional trainings to lawyers, accountants, and estate planners on technical aspects of federal, state, and city tax code—and make referrals for specialized employee education and financial services. Finally, as an agency of the State of New York, the NYS Center for Democratic Employee Ownership would continue to add credibility and legitimacy to the practice of business transfers—and, as appropriate, ease barriers for high-value business transfers.
Notably, the Ohio Employee Ownership Center was founded in 1987 and is responsible for assisting “employees in buying all or part of 92 companies, creating 15,000 employee-owners, at a cost in state funding of $772 per job created or retained” (NCEO n.d.). State centers also currently exist in Colorado, California, and Vermont.
Under NY General Municipal Law § 103, public contracts must be awarded to the lowest competitive bidder, or in certain cases on the basis of “best value.” NYS would create a new “carve out” for employee-owned firms and firms in which a portion of company stock is under democratic employee ownership, either directly through employee membership shares or indirectly through a democratic employee trust. This practice has a long and successful history of building community wealth in countries like Italy and France. This rule might be introduced as an amendment to State Finance Law § 162; or under the Executive Law, e.g., Article 17-B.
European Confederation of Cooperatives in Industry and Services (CECOP). 2012. “CECOP answer to the European Commission consultationEntrepreneurship 2020 Action Plan.” Brussels: CECOP-CICOPA Europe.
Magill, Roswell. 1959. “The Exemption of Cooperatives from Income Tax.” 21 Montana Law Review 2.
National Center for Employee Ownership (NCEO). 2014. “New Jersey Bill Would Encourage Employee Ownership.” August 1. http://www.nceo.org/employee-ownership-update/2014-08-01 (October 14, 2014).
––––––. National Center for Employee Ownership (NCEO). n.d. “Business Retention Through Employee Ownership: Resources for Economic Development Agencies.” Oakland: NCEO.
Reynolds, Bruce J. 2013. “Indivisible Reserves: Some See Unallocated Equity as a Way Co-ops Can Help Fortify Their Future.” 80 Rural Cooperatives 3. Washington, DC: USDA Rural Development.