Going, Going, Gone: Qualified Small Business Stock


You may or may not be aware of this, but come December 31, 2013, one of the most exciting tax incentives for investing in startups is going to expire.  What am I talking about?  The 100% exclusion from tax for investing in qualified small business stock.  This benefit expires on December 31, 2013, and it is unclear whether Congress will renew it.  What I mean by this benefit expiring is, if you want to set yourself up to take advantage of this benefit down the road (you have to hold the stock for 5 years to avail yourself of the tax break), you have to acquire the qualified small business stock before the end of this year.

What does the 100% exclusion entitle you to?

Up to $10M in capital gains can be entirely excluded from tax, including the alternative minimum tax.  What you generally have to do to qualify for exclusion is:

  • Form or invest in a C corporation before the end of this year.
  • Have that C corporation start actively conducting a business this year.  (Under IRC Section 1202, stock is not treated as qualified small business stock unless, during substantially all of the taxpayer’s holding period for such stock, the corporation was engaged in an active trade or business.)  What this means is it is not good enough to simply incorporate this year; the new corporation has to do business this year as well.  Obtain your business licenses, open your bank accounts, and do business.
  • Have that business qualify as a “qualified small business.”  For example, software and Internet companies typically qualify.

For a more thorough discussion, check out my post on Section 1202.

What should you consider doing?

  • If you are pondering an investment in a C corporation that you could close either this year or next year, you may want to close it this year, so that you can potentially take advantage of this tax benefit down the road.
  • If you have an LLC that you have been considering converting to a C corporation, you might want to do it before year end.
  • If you formed a C corporation this year, and you were thinking you made a mistake and should have been doing business as an LLC, this information may provide you with an additional reason  to remain a C corporation.

Call your tax lawyer or tax accountant if you are on the fence about what to do.

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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