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:


    (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.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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