New Legislation Benefiting 100% ESOP-Owned Defense Contractors
Author: David Solomon
For over 20 years, Congress has provided powerful incentives for S corporations to sponsor employee stock ownership plans (“ESOPs”) through the tax code provisions that exempt all of the income of a 100% ESOP-owned S corporation from federal income tax. At the end of last year, Congress struck again to specifically encourage 100% owned S-corporation ESOPs to be formed.
Section 874 of the National Defense Authorization Act (“NDAA”) signed into law by President Biden on December 27, 2021 created a pilot program that would allow companies that are or become a “qualified business wholly-owned through an employee stock ownership plan” and which bid on contracts procured by the United States Department of Defense to qualify to bid on “follow-on contracts” without going through a competitive bidding process. The statute defines a “qualified business wholly-owned through an employee stock ownership plan” as a 100% ESOP-owned S corporation.
This new program would not benefit a firm that is not already doing business with the U.S. Department of Defense because it only references the ability to obtain one single “follow-on contract” (i.e. a new contract for services that are the same or substantially similar to a contract that the company performed before they were a 100% ESOP-owned S corporation). However, for qualified firms, there may be further bidding opportunities if a “senior contracting official” approves the firm to get more than one “follow-on contract”.
There is also a restriction that would prevent sub-contracting more than 50% of the value of the contract, so if any of these firms rely on sub-contractors, they will have to change their practices. However, in three years, the Comptroller General will be required to submit a report to Congress to extend the pilot program so these limitations may change at some point.
Despite these limitations, the fact that Congress established the first-ever government contracting program to specifically encourage ESOPs is a strong signal that ESOPs are here to stay as an effective and powerful business succession strategy. For more information on how an ESOP may work for your company, please contact any of the members of LP’s ESOP Services Practice.