ESOPs were mentioned a few times in a report last week by the Joint Committee on Taxation, Tax Reform: Selected Federal Tax Issues Relating to Small Business and Choice of Entity (JCX-48-08), June 4, 2008:

This document, prepared by the staff of the Joint Committee on Taxation, provides data on the number and size of business entities in the United States, as well as a description of present law, issues, and analysis relating to choice of business entity, conversions of entity form, and payroll taxes.

The report was prepared for C, K, or S: Exploring the Alphabet Soup of Small Business Choices in Advance of Tax Reform, a public hearing conducted by the Senate Committee on Finance on federal tax issues related to small business and choice of entity.

The ESOP-related references can be put into two categories:

1. BIG - Built-In Gains Tax
   
   Page 49: Conversion from C corporation to S corporation - Proposals to reduce built in gain holding period Some have suggested shortening the 10-year period after conversion from C corporation to S corporation status, during which the built-in gains tax is imposed. For example, several bills have been introduced that would shorten the time period to 7 years following a conversion to S corporation status.92 The present-law 10-year period was intended to provide a sufficiently long holding period that conversion to S corporation form would not be an immediate escape from corporate level tax on asset sales. The same ten-year period currently applies (by reference to the S corporation rules of section 1374) under Treasury regulations for situations in which a C corporation merges with or otherwise becomes a REIT or RIC, special entity types that are required to make certain types of investments and that are not subject to corporate level tax provided they distribute or make deemed distributions of taxable income each year to their shareholders.93 In cases involving S corporations that are owned by ESOPs, any sales of built in gain property after the 10 years may be subject to no tax at all at the time of sale (rather than one level of tax at the time of sale).
   
   
2. Unrelated Business Income Tax (UBIT)
   
   Page 6: In most situations a tax-exempt investor, including any pension plan permitted to invest, would experience unrelated business income tax on its share of partnership, LLC, or S corporation business income. This is because business income is not generally considered exempt from tax even in the hands of a tax-exempt entity, unless it is received indirectly, in the form of dividends from a C corporation that has already potentially borne entity level tax. A notable exception to this general rule of business income taxation is the present law permitted investment of an ESOP in an S corporation without any unrelated business income tax on the income attributed to the ESOP. (footnote 12)
   
   Footnote 12: [See, e.g. Tribune Company Form 10-Q, First quarter 2008 p.7, n.3, available on the internet at http://www.sec.gov/Archives/edgar/data/726513/000072651308000018/firstquarter10q2008.htm.] Certain special entities, such as regulated investment companies and real estate investment trusts, can permit income of the entity to be non-taxed to the extent of tax-exempt organization ownership. However, such entities are generally required to invest in certain passive income assets and are not permitted to engage in active business.
   
   Tribune Company Form 10-Q: NOTE 3: INCOME TAXES S Corporation Election—On March 13, 2008, the Company filed an election to be treated as a subchapter S corporation under the Internal Revenue Code, which election is effective as of the beginning of the Company's 2008 fiscal year. The Company also elected to treat essentially all of its subsidiaries as qualified subchapter S subsidiaries. Subject to certain limitations (such as the built-in capital gains tax applicable for ten years to gains accrued prior to the election), the Company is no longer subject to federal income tax. Instead, the Company's income will be required to be reported by its shareholders. The Company's ESOP, the Company's sole shareholder (see Note 5), will not be taxed on the share of income that is passed through to it because the ESOP is a qualified employee benefit plan. Although most states in which the Company operates recognize the S corporation status, some impose income taxes at a reduced rate.
   
   As a result of the election and in accordance with FASB Statement No. 109, "Accounting for Income Taxes", the Company has eliminated approximately $1,859 million of net deferred income tax liabilities as of Dec. 31, 2007, and has recorded such adjustment as a reduction in the Company's provision for income tax expense in the first quarter of 2008. The Company will continue to report deferred income taxes relating to states that assess taxes on S corporations, subsidiaries which are not qualified subchapter S subsidiaries, and potential asset dispositions that the Company expects will be subject to the built-in gains tax.
   
   Footnote 41: Debt and equity investments also provide different consequences to certain investors in the pass-through regimes of partnerships and S corporations. For example, tax-exempt and foreign investors are generally not taxed on interest income from a partnership if they are debt investors, but generally would be taxed in their share of partnership income from business activity of the partnership if they are equity investors. The subchapter S rules do not permit foreign investors or certain tax-exempt investors to own stock of an S corporation. Those tax-exempt investors that may own S corporation stock, with the exception of ESOPs, are subject to an unrelated business income tax on their share of S corporation income. These factors can lead to a preference for structuring partnership or S corporation investment by such investors as debt.
   
   Page 33-34: In general, an S corporation shareholder is not subject to tax on corporate distributions unless the distributions exceed the shareholder's basis in the stock of the corporation or the corporation was formerly a C corporation and has undistributed earnings and profits. (Sec. 1368) its share of business income of the partnership is subject to unrelated business income tax. An S corporation likewise is not generally permitted to have a tax-exempt shareholder that is not subject to unrelated business income tax on S income, except that an ESOP is permitted to be a shareholder in an S corporation without unrelated business income tax. Below is a list of the principal differences in the taxation of the two types of entities and their owners:
   
   Page 35: Tax-exempt taxpayers (other than charities and qualified retirement plans) ineligible to be a shareholder. All items of income and loss of charities and qualified retirement plans (other than ESOPs) included in unrelated business taxable income; items of income and loss of ESOPs not included in unrelated business taxable income.
   
   Pages 42-43: Over the years, however, some of the shareholder restrictions on S corporation use have been relaxed. Most of the changes have simply expanded the number of permitted shareholders (today, 100, with expanded attribution rules), or have permitted the accommodation of certain family trust situations that are thought to approximate individual shareholders. (footnote 79) However, one very significant change now permits S corporations to offer a unique benefit, in which one specific type of tax-exempt shareholder (an ESOP) can be attributed business profits without the usual unrelated business income tax that would occur in a partnership. (footnote 80)
   
   Footnote 80: The following statement appears in the First Quarter 2008 10-Q of the Tribune Company with respect to the S election and ESOP shareholding of the Company: "As a result of the election and in accordance with FASB Statement 109, 'Accounting for Income Taxes', the Company has eliminated approximately $1,819 million of net deferred tax liabilities as of Dec. 31, 2007, and has recorded such adjustment as a reduction in the Company's provision for income tax expense for the first quarter of 2008." Tribune Company Form 10-Q, First quarter 2008, p.7, n. 3, available on the internet at http://www.sec.gov/Archives/edgar/data/726513/000072651308000018/firstquarter10q2008.htm.