Today, the U.S. House of Representatives passed the Small Business Bill. As soon as President Obama signs the bill, a 100% exclusion from tax on gains from qualified small business stock bought before the end of this year and held for more than 5 years will become law. This 100% exclusion will also be an exclusion from the alternative minimum tax on these gains. You can find the Section 1202 provisions of the Small Business Bill here. You can find the entirety of the Small Business Bill as passed by the House here.
In order to qualify for the 100% exclusion, the stock purchased must be qualified small business stock (in general, stock acquired on original issue from a domestic C corporation with gross assets of less than $50M, with at least 80% of the value of the the assets used in an active trade or business) and must be held for 5 years. See Section 1202.
Should we cheer? Will this incentivize investors to make investments in startups?
Sure, we should cheer. But it is too bad that the bill is only good until the rest of this year. And frankly, if we really wanted to incentivize investments in startups, there are other things that should be done as well–like opening up startup investing to a broader group of people, and allowing startups to publicly announce that they are seeking funding. Perhaps Congress will see to these items on another day.
100% Exclusion of Small Business Capital Gains. Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and before January 1, 2011, the exclusion is increased to 75 percent. At the time of sale, however, 28% of the excluded gain will be treated as a tax preference item subject to the alternative minimum tax (AMT). Qualifying small business stock is from a C corporation whose gross assets do not exceed $50 million (including the proceeds received from the issuance of the stock) and who meets a specific active business requirement. The amount of gain eligible for the exclusion is limited to the greater of ten times the taxpayer’s basis in the stock or $10 million of gain from stock in that corporation. This bill would temporarily increase further the amount of the exclusion to 100 percent of the gain from the sale of qualifying small business stock that is acquired after the date of enactment in 2010 and held for more than five years. Additionally, the bill eliminates the AMT preference item attributable for that sale. This provision is estimated to cost $518 million over ten years.