All posts tagged QSB

Section 1045: Let’s Fix It

Amend Section 1045If Congress is on the hunt for ideas to make life better for startups and emerging growth companies, here is another:

“Amend Section 1045 of the Internal Revenue Code to extend the 60 day rollover period to 6 months.”

First Off, What Is Section 1045?

Section 1045 is a tax code section that allows non-corporate taxpayers to rollover their gain on qualified small business stock, into other nonqualified small business stock. I’ve quoted the first part of Section 1045 below.

Why is Section 1045 important? Section 1045 is to startups what Section 1031 is to real estate. It encourages investments into startups. A noble objective!

Here is the operative provision I am recommending be amended:

    (a) Nonrecognition of gain
In the case of any sale of qualified small business stock held by a taxpayer other than a corporation for more than 6 months and with respect to which such taxpayer elects the application of this section, gain from such sale shall be recognized only to the extent that the amount realized on such sale exceeds—
(1) the cost of any qualified small business stock purchased by the taxpayer during the 60-day period beginning on the date of such sale, reduced by;
(2) any portion of such cost previously taken into account under this section.
    This section shall not apply to any gain which is treated as ordinary income for purposes of this title

Why Amend It?

60 days is a very short window in which to find a replacement investment. If you have ever done angel investing, you will know. To find and close an investment in 60 days is not an easy task. Usually investors hunt for months before they find an investment that they like. Then the paperwork to effectuate the investment can sometimes take weeks as well, if there is back and forth on various business points as the deal is negotiated.

In short, the Section 1045 statute exposes a lack of understanding on the part of the drafter as to how these transactions work. You can’t just call your broker and place an order. Most angel investments are not effectuated through a broker-dealer (which is one of the flaws of the crowdfunding bill–forcing companies who want to crowdfund to work through a broker-dealer).


We need is a Congressional representative to introduce a bill extending the 60 day window to 6 months. Very simple. Could someone please do this?

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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.
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House To Consider Bill Eliminating Capital Gains Taxes On Small Business Investments As Early As This Week

As reported in the Wall Street Journal, the House may consider as early as Thursday a bill that would temporarily eliminate capital gains taxes on qualified small business stock held for more than 5 years, in an attempt to drive investment capital toward small businesses that qualify as qualified small businesses under Section 1202 of the Internal Revenue Code. 

The bill would only open the window for the 100% exclusion for qualifying investments made between March 15, 2010 and before January 1, 2012. It seems unlikely, given the length of time it takes for startup companies to raise money, and for investors to make investment decisions in startups, that a window of opportunity this short will do anything other than bestow the benefit on parties who would already have been likely to make investments in startup companies during this period.

My suggestions to improve the bill:

  • Congress should consider the securities law aspects associated with investments in startups. For the most part, this tax benefit is only going to be available to “accredited investors,” the same group Congress wants to tax more heavily in other instances. Congress ought to make the securities law exemptions broader and more available to a greater group of people. For example, everyone (although this would run contrary to the Dodd bill, which would narrow the group of people who qualify as “accredited investors”).
  • If Congress’s desire is to drive capital into businesses that it perceives are creating jobs, it ought to make this tax exclusion permanent.
  • If Congress really wants to drive capital into businesses that it perceives are creating jobs, why not, instead of a capital gains exclusion available after 5 years, allow investments in these companies to be deducted in the year in which the investment is made? (Right now, investors who buy stock can’t recover the basis in their investment until they sell their stock; if you buy equipment, you can deduct that either all at once or over a fairly short period of time. In other words, the tax code heavily favors investments in equipment over investments in stock.)
  • Or even better, give investors a dollar-for-dollar tax credit for their investments?
  • Or even better, give investors a dollar-for-dollar tax credit for money paid to employ people in any job?

What would Secretary Newco say? What would Glenn Kelman say? I think I know what @cdixon would say. What would Michael Arrington say?

The exclusion is summarized by the Ways and Means Committee as follows:

100% Exclusion of small business capital gains. Under current law, Section 1202 provides a fifty-percent (50%) exclusion for gain from the sale of certain small business stock that is held for more than five years. The amount of gain eligible for the Section 1202 exclusion is limited to the greater of 10 times the taxpayer’s basis in the stock, or $10 million gain from stock in that small business corporation. This provision is limited to individual investments and not the investments of a corporation. The non-excluded portion of section 1202 gain is taxed at the lesser of ordinary income rates or 28 percent, instead of the lower capital gains rates for individuals. The American Reinvestment and Recovery Act (the “Recovery Act”) temporarily increased the Section 1202 exclusion to seventy-five percent (75%) for qualifying stock acquired in 2009 and 2010. The bill would temporarily increase the amount of the exclusion to one hundred percent (100%) for qualifying stock acquired after March 15, 2010 and before January 1, 2012. This provision is estimated to cost $1.962 billion over 10 years.

More information on this bill is available at the Ways and Means Committee web site.

The opinions expressed here are my own.

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