On November 3, 2010 and January 18, 2011, we issued client alerts discussing the opportunities provided by the Section 1202 exclusion from tax on gain realized on the sale of certain stock issued by a “qualified small business corporation” (a “QSBC”). These alerts discussed Congress’ increase of the exclusion percentage to 100% with respect to stock issued by a QSBC between September 27, 2010 and December 31, 2011. On January 2, 2013, the president signed the American Taxpayer Relief Act (“ATRA”), which again extended the increase in the 1202 exclusion to 100%; this time for stock issued by QSBCs during calendar years 2012 and 2013. ATRA also includes other important provisions impacting taxes, including changes in the income tax and capital gains tax rates for taxpayers with incomes above certain thresholds.
Benefits of the ExclusionThe 100% exclusion shields up to $10 million (or, if greater, 10 times the amount of the taxpayer’s investment in the stock) of gain recognized on the sale of stock issued by a QSBC after September 27, 2010 and no later than December 31, 2013, so long as the taxpayer holds the stock for more than five years prior to sale. This exclusion of gain applies not only to the computation and payment of federal income taxes (including the new 3.8% “Medicare” tax on net investment income and the alternative minimum tax), but may also shield the gain from state income taxes (unless the state, like California, includes an “add back” when calculating state income taxes).
The 100% exclusion is primarily an incentive for QSBCs to raise new equity capital before the end of 2013. As such, it is an incentive for individuals, estates, and trusts seeking investment opportunities in start-up and other early stage corporate ventures as well as existing small and middle-market corporations.
Certain Eligibility Requirements Apply
Eligible Transactions and Planning Considerations
Confusion Caused by the New LegislationATRA added a “technical amendment” to the Section 1202 75% (applicable to stock issued by a QSBC after February 17, 2009 through September 27, 2010) and 100% exclusion rates. The amendment states that the “acquisition” of QSBC stock for purposes of determining its exclusion percentage (i.e., 75% or 100%) “shall be the first day on which such stock was held by the taxpayer determined after the application of section 1223.” The legislative history of related legislation suggests that Congress intended that this technical correction apply only in the case of a Section 1045 Roll Over transaction. There is no indication in the legislative history of ATRA that Congress intended to change any other provisions of Section 1202. However, read in a vacuum, the language of the technical correction could be read as indicating that stock issued by a QSBC in exchange for property in a Section 351 transaction was issued on the date on which the contributed property was acquired as opposed to the date on which the stock was issued. This interpretation is contrary to other provisions of Section 1202 that were not amended by ATRA.
This glitch in the drafting of the ATRA technical correction to Section 1202(3) and (4) has been brought to the attention of the Congressional tax legislation committees. We understand that the committees are considering methods to clarify Congress’ intent with respect to the technical correction.
ConclusionThe recent extension of the 100% exclusion from tax on the sale of QSBC stock issued before the end of this year provides many tax-planning opportunities for start-ups, early stage ventures, and small and middle-market businesses. If you are interested in exploring the possibilities presented by the extension of the 100% exclusion or any other aspects of ATRA, we urge you to contact a member of the K&L Gates tax or emerging growth and venture capital groups.
Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code of 1986, as amended or (ii) promoting, marketing or recommending to another party any transaction or matter addressed within.
This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. Any views expressed herein are those of the author(s) and not necessarily those of the law firm’s clients.