Congress Extends Exclusion for Investors in Qualified Small Businesses

by Baker Donelson
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Among the taxpayer-favorable aspects of the American Taxpayer Relief Act of 2012 (Act), the 100 percent exclusion from gross income of gain on the sale of Qualified Small Business Stock (QSBS), provided for in section 1202 of the Internal Revenue Code, was extended for an additional year. Therefore, gain from the sale of QSBS purchased during the period between September 2010 and December 31, 2013 will not be subjected to tax, provided certain requirements are met. 

Historically, this exclusion only provided taxpayers with a 50 percent exclusion (75 percent for QSBS purchased between February 2009 and September 2010) from gross income attributable to gain from the sale of QSBS, with the remaining non-excluded gain taxed at the 28 percent rate. The 50 percent exclusion and higher 28 percent rate resulted in an effective tax rate of approximately 14 percent (7 percent for QSBS purchased between February 2009 and September 2010).

The purpose of this exclusion is to encourage investment in new ventures.  Therefore, certain requirements for qualification exist, which include the following:

  • The stock must be purchased or acquired by a contribution of property or services at the time of its original issuance by the corporation and must be held for a period of more than five years;
  • The interest held must actually be stock in the Qualified Small Business (not warrants, etc.);
  • The holder of QSBS may be any taxpayer, including a partnership; however, corporations are not eligible to claim this exclusion;
  • The maximum amount of gain eligible for exclusion with respect to a single issuer is the greater of $10 million or 10 times the taxpayer’s basis in the QSBS; and
  • The corporation issuing the stock must be a “Qualified Small Business,” which among other requirements means the corporation is a C corporation, has no more than $50 million in gross assets prior to the issuance of such QSBS, and employs at least 80 percent of its assets (measured by value) in the active conduct of one or more trades or businesses, but generally excluding service businesses.

Barring any further extensions of this 100 percent exclusion, the 50 percent exclusion will return for QSBS purchased after December 31, 2013. This is an important development for those taxpayers that are interested in making investments in startup or otherwise qualifying small corporations during the 2013 calendar.

Should you have any questions regarding the qualification of a specific investment under this exclusion from income tax, or have any other questions regarding the effects of the Act, please contact one of the following attorneys in the Firm’s Tax Department:

Jackson, Mississippi
James K. Dossett Jr. 601.351.2482 jdossett@bakerdonelson.com
Stacy E. Thomas 601.351.2484 sthomas@bakerdonelson.com
Leonard (Len) C. Martin 601.351.2453 lmartin@bakerdonelson.com
David P. Webb 601.969.4678 dwebb@bakerdonelson.com
Jon D. Seawright 601.351.8921 jseawright@bakerdonelson.com
C. Tyler Ball 601.351.8959 tball@bakerdonelson.com

Atlanta, Georgia
Nedom A. Haley 404.221.6505 nhaley@bakerdonelson.com
Robert G. Brazier 404.221.6506 rbrazier@bakerdonelson.com
Michael M. Smith 404.589.3419 mmsmith@bakerdonelson.com
Michael S. Evans 404.221.6517 mevans@bakerdonelson.com

Nashville, Tennessee
Scott D. Smith 615.726.7391 sdsmith@bakerdonelson.com
Carolyn W. Schott 615.726.7312 cschott@bakerdonelson.com
Richard D. Bird 615.726.7327 rbird@bakerdonelson.com
Daniel A. Stephenson 615.726.5678 dstephenson@bakerdonelson.com

Memphis, Tennessee
William H.D. Fones Jr. 901.577.2247 wfones@bakerdonelson.com
Paul R. O'Rourke 901.577.2313 porourke@bakerdonelson.com
Mary Ann Jackson 901.577.8113 mjackson@bakerdonelson.com
Charles Eldon Pierce 901.577.2164 cpierce@bakerdonelson.com

East Memphis, Tennessee
James R. (Josh) Hall Jr. 901.579.3126 joshhall@bakerdonelson.com
Christopher J. Coats 901.579.3127 ccoats@bakerdonelson.com

Chattanooga, Tennessee
Carl E. Hartley 423.756.2010 chartley@bakerdonelson.com
Virginia C. Love 423.209.4118 vlove@bakerdonelson.com
Philip B. Whitaker 423.209.4118 pwhitaker@bakerdonelson.com
William E. Robinson 423.209.4107 wrobinson@bakerdonelson.com
Sara Elizabeth McManus 423.209.4124 smcmanus@bakerdonelson.com

Knoxville, Tennessee
L. Eric Ebbert 865.971.5182 eebbert@bakerdonelson.com

Birmingham, Alabama
Thomas J. Mahoney Jr. 205.250.8346 tmahoney@bakerdonelson.com
Robert T. Gardner 205.250.8373 rgardner@bakerdonelson.com
Andrea B. Powers 205.244.3809 apowers@bakerdonelson.com
Adam Sidney Winger 205.250.8381 awinger@bakerdonelson.com

Orlando, Florida
Donald E. Christopher 407.367.5402 dchristopher@bakerdonelson.com
Richard C. Swank 407.367.5404 rswank@bakerdonelson.com
Martha A. Hartley 407.367.5427 mhartley@bakerdonelson.com

Houston, Texas
Brad Chambers 713.286.7193 bchambers@bakerdonelson.com

New Orleans, Louisiana
Robert L. Wollfarth 504.566.8623 rwollfarth@bakerdonelson.com

Baton Rouge, Louisiana
Alton E. (Biff) Bayard III 225.381.7019 abayard@bakerdonelson.com

Washington, D.C.
James W. McBride 202.508.3467 jmcbride@bakerdonelson.com

 

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.

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