By Alfia Catapano
Investors have a unique opportunity to purchase tax-advantaged equity in entrepreneurial companies before year-end 2011. For qualified stock purchases and grants held for more than five years, all gains are tax-free – and exempt from alternative minimum tax provisions as well.
The Small Business Jobs Act of 2010 provides unique opportunities and incentives for investors through changes to various provisions in the tax code. Of particular note as we approach the end of 2011 are the amendments the SBJA made to Internal Revenue Code Section 1202. That section provides a partial exclusion from gross income on gain from transfers of certain qualified small business stock and is likely to be of importance to our clients with investments in eligible small businesses.
The amendment to §1202 expands the exclusion from 50% to 100% of gain.
Prior to the enactment of the Small Business Jobs Act, §1202 provided that 50% of gain on the sale or exchange of certain qualified small business stock would be excluded from the gross income of the transferor, provided the transferor met certain requirements and held the stock for more than five years. While the SBJA makes no change to the original requirements for eligibility or the necessary holding period, it adds a new provision that will allow taxpayers to exclude 100% of such gain on stock that was acquired between September 27, 2010 (the enactment date of the Small Business Jobs Act) and December 31, 2011.
Gain on stock acquired before January 1, 2012 will not be subject to Alternative Minimum Tax.
In addition to expanding the exclusion to 100% of gain on such transfers, the SBJA repealed the application of IRC §57(a)(7) which would otherwise make a percentage of the excluded gain an item of AMT preference. The AMT preference would often negate much of the benefit otherwise derived from §1202. Under the amended provision however, any gain is completely excluded from both regular taxable income and Alternative Minimum Taxable Income. Exclusion from AMTI can be a significant additional benefit.
Qualified Small Business Stock
Section 1202 provides these benefits only for gains on qualified business stock and the requirements for qualification remain unchanged by the SBJA amendments. In order to qualify, stock must be:
- Acquired by the taxpayer/transferor at original issue
- Acquired by the taxpayer/transferor in exchange for money or other property (not including stock) or as compensation for services provided to such corporation.
Additionally, the small business issuing the qualified stock also must meet several criteria. The business must:
- Be a domestic C-corporation
- Be an active business or a “specialized small business investment company”
- Have gross assets that do not exceed $50,000,000
- Be engaged in a qualified trade or business as set out by §1202(e)3
The requirements for qualifying small businesses listed above are a brief summary of those detailed in §1202(d)-(e). The statute should be consulted when making a determination of qualification on a per-taxpayer basis.
Year End Planning Opportunity
As December 31, 2011 approaches, we advise any clients who may have options to purchase qualifying small business stock to consider doing so before year-end. Acquiring the options themselves will not suffice; instead, taxpayers must actually exercise those options in order to fall under the provisions of the statute. The unique benefit provided by the SBJA amendment to §1202 will not be available on stock acquired on January 1, 2012. Gain on after-acquired stock will again be limited to a 50% exclusion as well as subject to AMT at applicable rates. In order to take advantage of the benefit provided by the Small Business Jobs Act, taxpayers will need to acquire eligible small business stock prior to 2012.
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This information has been prepared by GC LLC for general informational purposes only. It does not constitute legal advice, and is presented without any representation or warranty as to its accuracy, completeness or timeliness. Transmission or receipt of this information does not create an attorney-client relationship with GC LLC or its affiliates. The contents of these materials may constitute attorney advertising under the regulations of various jurisdictions.
IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein. For more information on this disclaimer, please see the Gibbons website