Congress Extends 100% Exclusion For Gains From Sales Of Qualified Small Business Stock

by Orrick, Herrington & Sutcliffe LLP
Contact

As a pleasant surprise to many investors, the recently enacted American Taxpayer Relief Act of 2012 (the “Act”) extends the 100% exclusion for gains from sales of Qualified Small Business Stock (“QSB Stock”) to QSB Stock acquired in 2012 (retroactively) and 2013. 

Historically, non-corporate investors that sold QSB Stock held for five years or more were permitted under Section 1202 of the Internal Revenue Code to exclude 50% of the gain recognized on such sale when computing their federal income tax liability (increased to 75% generally for investments made in 2009 and 2010).  The remaining 50% of gain, however, was taxed at a 28% rate, producing an overall tax rate of 14% (ignoring the alternative minimum tax) and only a minimal advantage over the general 15% long-term capital gain rate. 

The Small Business Jobs Credit Act of 2010 increased the gain exclusion to 100% for purchases of QSB Stock made after September 27, 2010 and before January 1, 2011.  The 100% exclusion was later extended to QSB Stock purchases made in 2011, and now the Act has further extended the 100% exclusion through the end of 2013.

LIMITATIONS:  Many requirements must be met in order to qualify for the favorable gain exclusion rule, some of which are within the control of the issuer of the stock (and outside the control of the investor).  The most notable requirements are as follows:

  1. The stock must be stock in a “C” corporation.
  2. In general, the stock must be acquired by the investor at original issuance.
  3. At the time of the stock issuance, the corporation must have gross assets of $50 million or less (including assets received by the corporation in the stock issuance).
  4. For substantially all of the time during which the investor holds the stock, the corporation must be actively engaged in a qualified trade or business.  A qualifying trade or business does not include professional service organizations (law, accounting architecture, etc.), banking, farming, mining, or hotel and restaurant management.
  5. The corporation must use at least 80% of its assets, measured by value, in the active conduct of such qualified trade or business.  Cash held for anticipated working capital needs generally qualifies but is capped at 50% of the assets of the corporation if the corporation has been in existence for at least two years.
  6. No more than 10% of the corporation’s assets may consist of stock or securities in other corporations (other than 50%-or-more owned subsidiaries) or real property not used in the active conduct of a business.  Owning, dealing in, or renting real property is not an active business for this purpose.
  7. The amount of gain that is eligible for exclusion under this provision is equal to the greater of (a) 10 times the investor’s basis in the stock or (b) $10 million.  Special rules apply for stock acquired in exchange for property.
  8. The corporation cannot make significant redemptions during the two-year period starting one year before the particular investment.
  9. The investor must generally hold the QSB Stock for five years.  Under certain circumstances an investor may defer gain on the sale of QSB Stock in a reorganization or by reinvesting the proceeds of a sale into other QSB Stock, in which case the two holding periods are tacked together.

CALIFORNIA TAX TREATMENT: Although the California statute provides a 50% exclusion for QSB Stock that is similar to the federal exclusion, the availability of the California exclusion is currently uncertain. 

California’s standard for QSB Stock mirrors Section 1202 of the Internal Revenue Code, but also requires that the corporation use 80% of its assets in the conduct of business in California and maintain 80% of its payrolls in California.  Recently, the California Court of Appeals declared the California QSB Stock exclusion to be unconstitutional under the Commerce Clause because it discriminates against investors in out-of-state corporations.  Although the decision has been remanded to the trial court for further proceedings, the California taxing authorities have preemptively taken the position that the California QSB Stock exclusion is invalid and unenforceable as to all investors, including investors in corporations meeting the 80% of assets and payrolls requirement.  Although it is uncertain to what extent the California QSB Stock exclusion will ultimately apply, clearly investors should not stop purchasing QSB Stock or seeking special federal tax treatment for such investments.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Orrick, Herrington & Sutcliffe LLP | Attorney Advertising

Written by:

Orrick, Herrington & Sutcliffe LLP
Contact
more
less

Orrick, Herrington & Sutcliffe LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!