Posted on June 15, 2010 by Joseph M. Wallin

House Passes 100% Exclusion On Sales of Certain Qualified Small Business Stock

Today the House passed a bill which would completely exempt from capital gains taxes (subject to per taxpayer limitations) the gain on the sale of qualified small business stock held for more than 5 years, if such stock was purchased after March 15, 2010, and before January 1, 2012. It is unclear if the Senate will pass this bill. The bill also makes clear that no part of the exclusion is an alternative minimum tax adjustment. The provision as passed by the House is quoted below.

For press coverage, see The Hills' coverage.

If the Senate passes this provision, a lot more intensity will be brought to bear on representations and warranties in stock purchase agreements that stock being purchased qualifies as "qualified small business stock." In addition, special scrutiny will be brought to bear on redemptions and other historical transactions which could disqualify stock from qualifying.

As I've indicated before, I think that the short window in which this 100% exclusion is actually available makes it sort of a gimmick. It seems to me that only individual investors who would otherwise have been likely to invest in qualifying companies during this window already will be the ultimate beneficiaries of this provision. So, think of it like a bailout in a sense for taxpayers in that spot. If Congress really wanted to shift behavior, it would enact permanent tax reductions of some kind related to investments--not short term gimmicks and ploys. Still, for qualifying investors, it is hard to complain.

In general, "qualified small business stock" is stock in a C corporation acquired by a taxpayer at its original issue if as of the date of issuance such corporation was a "qualified small business," and during substantially all of the taxpayer's holding period for such stock, the corporation met certain active business requirements and was a C corporation. A "qualified small business" in general means a business with less than $50 million in gross assets. The active business requirements require that at least 80 percent (by value) of the assets of the corporation be used by the corporation in the active conduct of 1 or more "qualified trades or businesses."

“Qualified trade or business” means trade or business other than:

  • trades or businesses involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees;
  • any banking, insurance, financing, leasing, investing or similar business;
  • any farming business (including the business of raising or harvesting trees);
  • any business involving the production or extraction of products of a character with respect to a which a deduction is allowable under Section 613 or 613A;and
  • any business of operating a hotel, motel, restaurant or similar business.

The provision as passed:

SEC. 501. TEMPORARY EXCLUSION OF 100 PERCENT OF GAIN ON CERTAIN SMALL BUSINESS STOCK.

    (a) In General- Subsection (a) of section 1202 is amended by adding at the end the following new paragraph:
      `(4) SPECIAL 100 PERCENT EXCLUSION- In the case of qualified small business stock acquired after March 15, 2010, and before January 1, 2012--
        `(A) paragraph (1) shall be applied by substituting `100 percent' for `50 percent',
        `(B) paragraph (2) shall not apply, and
        `(C) paragraph (7) of section 57(a) shall not apply.'.
    (b) Conforming Amendments- Paragraph (3) of section 1202(a) is amended--
      (1) by striking `after the date of the enactment of this paragraph and before January 1, 2011' and inserting `after February 17, 2009, and before March 16, 2010'; and
      (2) by striking `SPECIAL RULES FOR 2009 AND 2010' in the heading and inserting `SPECIAL 75 PERCENT EXCLUSION'.
    (c) Effective Date- The amendments made by this section shall apply to stock acquired after March 15, 2010.

 

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Posted on January 28, 2010 by Joseph M. Wallin

Obama Shout Out To Zeroing Out Capital Gains On QSB Stock

We've written about this before. The President has proposed to reduce the capital gains tax rate on qualified small business stock to zero.

He said it again last night in his State of the Union speech.

You can view the video below. The President's comment is at minute 6:50. He says:

"While we're at it, let's also eliminate all capital gains taxes on small business investment."

Reducing the capital gains tax rate to zero on qualified small business stock would be extremely beneficial to businesses that qualify for the QSB tax benefit, and would probably create a flood of investment in that direction.

Also see this article on pehub.

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Posted on December 30, 2009 by Joseph M. Wallin

Sure, You've Heard of 1031 Exchanges, But What About 1045 Exchanges?

By Michael Gentile

The Internal Revenue Code contains a number of preferential tax treatment provisions for small businesses. One that is often overlooked is Section 1045, which generally permits a non-corporate taxpayer to elect to defer recognizing gain on the sale of qualified small business (QSB) stock held for more than six months to the extent the proceeds are reinvested in other QSB stock during a 60-day period beginning on the date of the sale.  

With certain exceptions, QSB stock means any stock acquired on original issuance by the taxpayer from a domestic C corporation after August 10, 1993 that meets the following requirements: (1) the aggregate gross assets of the corporation must not have exceeded $50 million at the time of and immediately after the issuance of the stock; and (2) at least 80% of the value of the corporation's assets must have been used in an active trade or business.  IRC Section 1202.

Section 1045 permits founders and angel investors to move money from one business venture to the next without having to pay tax on appreciation in the first business venture.  Because the benefit of Section 1045 applies only to stock in C corporations, it should be taken into consideration by entrepreneurs in choosing the form of their business ventures.
 
If you form as an S corporation, you will not be able to access the benefits of Section 1202 or Section 1045 with respect to your founders' stock.
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Posted on May 11, 2009 by Joseph M. Wallin

Obama Proposes No Capital Gains Tax At All On QSB Stock Held For 5 Years

In what could be a very welcome development in startup land, if it becomes law, President Obama has proposed that there be NO capital gain taxation of gains from the sale of qualified small business stock issued after February 17, 2009 and held for 5 years.  Presumably the limitations of IRC 1202 that cap the QSB benefit at the greater of (i) 10x a taxpayer's basis in stock issued by the corporation and disposed of during the year, or (ii) $10M reduced by gain excluded in prior years on dispositions of the corporation's stock would still apply.  However, this would still be quite a benefit.

See pages 13-14 of this document.  The entirety of pages 13 and 14 are also quoted below.

 

Entirety of pages 13-14 from General Explanations:

ELIMINATE CAPITAL GAINS TAXATION ON INVESTMENTS IN SMALL BUSINESS STOCK

Current Law

Taxpayers other than corporations may exclude 50-percent (60 percent for certain empowerment zone businesses) of the gain from the sale of certain small business stock acquired at original issue and held for at least five years. Under ARRA the exclusion is increased to 75 percent for stock acquired in 2009 (after February 17, 2009) and in 2010. The taxable portion of the gain is taxed at a maximum rate of 28 percent. Under current law, 7 percent of the excluded gain is a tax preference subject to the alternative minimum tax (AMT). The AMT preference is scheduled to increase to 28 percent of the excluded gain on eligible stock acquired after December 31, 2000 and to 42 percent of the excluded gain on stock acquired on or before that date.

The amount of gain eligible for the exclusion by a taxpayer with respect to any corporation during any year is the greater of (1) ten times the taxpayer's basis in stock issued by the corporation and disposed of during the year, or (2) $10 million reduced by gain excluded in prior years on dispositions of the corporation’s stock. To qualify as a small business, the corporation, when the stock is issued, may not have gross assets exceeding $50 million (including the proceeds of the newly issued stock) and may not be an S corporation.

The corporation also must meet certain active trade or business requirements. For example, the corporation must be engaged in a trade or business other than: one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any other trade or business where the principal asset of the trade or business is the reputation or skill of one or more employees; a banking, insurance, financing, leasing, investing or similar business; a farming business; a business involving production or extraction of items subject to depletion; or a hotel, motel, restaurant or similar business. There are limits on the amount of real property that may be held by a qualified small business, and ownership of, dealing in, or renting real property is not treated as an active trade or business.

Reasons for Change

Because the taxable portion of gain from the sale of qualified small business stock is subject to tax at a maximum of 28 percent and a percentage of the excluded gain is a preference under the AMT, the current 50-percent provision provides little benefit. Increasing the exclusion would encourage and reward new investment in qualified small business stock.

Proposal

Under the proposal the percentage exclusion for qualified small business stock sold by an individual or other non-corporate taxpayer would be increased to 100 percent and the AMT preference item for gain excluded under this provision would be eliminated.  The stock would have to be held for at least five years and other provisions applying to the section 1202 exclusion would also apply. The proposal would include additional documentation requirements to assure compliance with the statute.

The proposal would be effective for qualified small business stock issued after February 17, 2009.
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