23 Nov 2010 Tax-Free Opportunity for Investments in Small Businesses
In late September of this year, the federal government passed the Small Business Jobs Act of 2010 (“SBJA 2010”). Among other things, SBJA 2010 provides for an exclusion of 100% of the gain realized on the sale of certain qualified small business stock (“QSBS”) held for at least five years, if such QSBS is acquired or issued between September 27, 2010 and January 1, 2011.
QSBS, subject to a few exceptions, means stock in a domestic corporation if: (1) such corporation is a “qualified small business” (“QSB”) at the time the stock is issued; and (2) the taxpayer acquires the stock, in an original issuance of such stock, in exchange for money, other property, or as compensation for services to the issuing corporation. In general, a QSB is a domestic C corporation, with $50 million or less in gross assets (without regard to liabilities) that is engaged in an “active business” (i.e. cannot be an investment company).
Existing Section 1202 of the Internal Revenue Code of 1986, as amended (the “Code”) permits taxpayers, other than corporations, to elect to exclude 50% of the gain realized from the sale of QSBS held for at least five years (with such exclusion subject to a cap). In certain cases involving Empowerment Zones, the exclusion is increased to 60%, and for QSBS acquired or issued between February 17, 2009 and September 28, 2010, the federal government increased the exclusion to 75%. In the past, taxpayers pursuing the QSBS exclusion were unable to realize any significant benefit because the amount excluded was treated as a tax preference for alternative minimum tax (“AMT”) purposes. Essentially, a taxpayer subject to AMT would end up with nearly the same tax liability, regardless of such taxpayer’s election to exclude gain under Section 1202. The Section 1202 exclusion for a taxpayer is limited to greater of (i) $10 million or (ii) 10 times such taxpayer’s basis in the QSBS.
SBJA 2010 not only increases the Section 1202 gain exclusion to 100%, but removes the excluded gain from the list of AMT tax preference items. Therefore, a taxpayer electing for exclusion under Section 1202 will have a zero federal tax liability with respect to the sale of QSBS held for at least five years, if such QSBS is acquired or issued between September 27, 2010 and January 1, 2011. Tax-free gain is a rare opportunity for taxpayers in the United States; and before you know it, this opportunity will be gone.Disclaimer: This blog and website are public sources of general information concerning our firm and its lawyers, as well as the information presented. They are intended, but not promised or guaranteed, to be correct, complete, and up-to-date as of the date posted. This blog and website are not intended to be, and are not, sources of legal opinion or advice. The materials, information, and communications on this blog and website do not apply to any particular person, entity, or situation, and do not apply to you or to your specific situation. You will need to consult with an attorney and/or other appropriate professional about your specific situation. Thank you.