Banks would lose a big incentive for financing employee buyouts under a Congressional plan to give tax breaks to small businesses.

The House passed a bill May 24 granting $7.1 billion in new tax breaks for small businesses over eight years. To help cover the cost, lawmakers voted to eliminate a 50% deduction on interest income from loans to employee stock ownership plans.

By eliminating the deduction, banks would lose a sweetener that helped induce them to make loans to employee stock ownership plans, said Herb Spira, tax counsel for the Independent Bankers Association of America.

"This would take away an incentive," Mr. Spira said. "There's a lot of interest in using ESOPs and they help employees at both large and small companies."

The repeal is retroactive and would apply to loans made after Oct. 13, 1995. The Senate is expected to take up the measure within the next two weeks. Only loans to employee stock ownership plans holding majority stakes qualify for the deduction.

No one has measured how many banks take advantage of the tax break. But Michael Keeling, president of the ESOP Association, said roughly 1,500 of the 10,000 existing ESOPs meet the criteria.

To preserve the ESOP writeoff, Congress would have to find new ways to offset the small-business tax breaks, which include larger deductions for personal property expenses and for employer contributions to Social Security.

Congressional staffers estimated that eliminating the deduction for employee stock ownership plans would provide $1.3 billion in new revenue through 2003, but Mr. Keeling scoffed at that figure.

"The revenue estimate is absolutely ridiculous," Mr. Keeling said.

He said banks use the deduction on no more than 50 new loans a year, averaging $5 million each. The annual loss to the Treasury: only $3.5 million.

Lawmakers pushing to eliminate the deduction, including House Ways and Means Committee Chairman Bill Archer and Senate Majority Leader Bob Dole, argued the deduction doesn't help employee stock ownership plans, only banks.

Mr. Keeling disagreed. "The tax break is shared with the borrower," he said. "I know of no instance where banks used the deduction and did not charge a lower interest rate."

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