06-19-2015
On December 19th, 2014, President Barack Obama signed into law the 2014 Tax Increase Prevention Act (“TIPA 2014”). §1202 of the Internal Revenue Code previously allowed a 100% capital gain exclusion for Qualified Small Business Stock (“QSBS”) purchased in parts of 2010 up until December 31st, 2013. TIPA 2014 subsequently extended §1202’s 100% exclusion for QSBS to such stock purchased on, or before December 31st, 2014. There is no indication yet of whether the exclusion will be extended yet again, but Congress has seen fit to extend it three times so far.
What does this mean practically speaking? Founders, along with others with original issue stock, can get a possible 0% effective tax rate on gains from the sale of all or part of their business, as long as the acquisition and sale of the business was, and is structured properly. Do not feel too let down, however, if your stock does not fall into the 100% exclusion period, you may still be eligible for a 50%, 60%, or 75% exclusion under §1202.
Qualified Small Business
Qualified Small Businesses are generally the only entities who can issue QSBS. A Qualified Small Business is (1) a domestic C corporation (but not a Disc, RIC, REIC, REMIC, Cooperative, or various other corporations); (2) whose aggregate gross assets before issuance, and up until immediately after issuance, do not exceed $50,000,000; (3) which agrees to submit any reports as required by the IRS (no reports are currently required); and (4) which is engaged in an active business during substantially all of a taxpayer’s holding period of the QSBS.
The active business requirement is met if 80% or more of the corporation’s assets are used by the corporation in actively conducting certain qualified trade or business. A business or trade is generally qualified for the purposes of §1202 if it does not involve: (1) the provision of one of several services (i.e. law, accounting, or engineering), or (2) doing business in any one of several industries (i.e. farming, banking, and oil and gas).
Qualified Small Business Stock
Stock is considered QSBS if it is original issue stock (not previously owned) in a qualified trade or business, received in exchange for money or property (other than stock), or as compensation for services to the corporation (other than services as an underwriter of the stock).
Finally, for the exclusion to qualify as to your gain the stock being sold must have been held for more than five years.
California’s QSBS
California has its own similar 50% exclusion at the state level, set out in Revenue & Taxation Code §18152.5. The main difference is the requirement that the corporation have at least 80% of its payroll be attributable to employment in California at the time the stock is issued. Unfortunately §18152.5 does not apply to sales made after January 1, 2013. However, if you sold your stock before 2013 but are still taking installment payments for that sale, you may be eligible for the 50% exclusion.
For advice on whether your business may be a Qualified Small Business, or if you have Qualified Small Business Stock, it is recommended that you contact a professional who is qualified to render such counsel.
The information contained on this web-site is not legal advice. The information may not reflect the most up-to-date legal developments. Unless otherwise indicated in writing, any US federal tax advice contained in this web-site is not intended to be used, and cannot be used to (i) avoid penalties under the US Internal Revenue Code, or (ii) promote, market or recommend to another party any matter addressed herein.