When you have high tax rates, you make taxpayers highly-motivated to carve out exemptions for themselves. That’s how you get things like HF 633, which cleared the Iowa House of Representatives this week.
The bill would allow employee-owners of businesses to make a one-time election to exclude from Iowa taxable income gain from the sale of employer stock. From the bill (my emphasis):
(a) An employee-owner is entitled to make one irrevocable lifetime election to exclude the net capital gain from the sale or exchange of capital stock of one qualified corporation which capital stock was acquired by the employee-owner on account of employment by such qualified corporation and while employed by such qualified corporation.
(b) The election shall apply to all subsequent sales or exchanges of the elected capital stock, provided it is capital stock in the same qualified corporation and was acquired on account of employment by such qualified corporation and while employed by such qualified corporation.
What is “Capital stock?” From the bill:
“Capital stock” means common or preferred stock, either voting or nonvoting. “Capital stock” does not include stock rights, stock warrants, stock options, or debt securities.
What is a “qualified corporation?” The bill says that would be:
(A) The corporation has been in existence and actively doing business in this state for at least ten years.
(B) The corporation has at least five shareholders.
The “ten year” thing would seem to be an attempt to pair up somehow with the ten-year capital gain exclusion for ten-year businesses — but unlike that provision, it lacks a ten-year holding period and material participation requirement. The “five shareholders” requirement is baffling — and could be easily be avoided by minor share gifts before a sale to create shareholders.
What does it mean to acquire shares “on account” of employment? The bill doesn’t say. Would exercising options under a stock option plan qualify? Is it limited to employer stock bonus plan stock? What if an employee buys stock as an investment? What about founding owners? The bill is unclear, and it shouldn’t be.
I am guessing this bill is being driven by the executives at publicly-traded Iowa corporations, and maybe by Hy-Vee executives, who benefit from employee ownership. While you can’t blame them for trying to carve themselves a break, it would be much better for the rest of us to eliminate this sort of special favor, make the law simpler, and lower rates for everyone. In other words, The Tax Update Quick and Dirty Iowa Tax Reform Plan.