Thursday, September 30, 2010

Entrepreneurs Can Escape Capital Gains

       As a part of the Small Business Bill signed into law on September 23rd, section 1202 of the Internal Revenue Code will be amended to provide for an exclusion of capital gains on small business qualified stock held for more than five years.  In sum, certain investors in startup companies will pay no tax on the disposition of the stock.  Indeed, the current administration is providing a huge tax break to entrepreneurs looking for an exit strategy. 

       In order to qualify, the stock must be held by the taxpayer by January 1, 2011.  So if you already own the stock don’t worry.  But if you are contemplating the startup of a new company, closing the transaction and issuing the stock within the next three months will provide for 100% exclusion on capital gains and an exclusion from the alternative minimum tax on these gains if the stock is sold after five years. 

       Additionally, the exclusion is available for taxpayers who received eligible stock from its original issuance, and the corporation meets the requirements that it actively conducts a qualified trade or business and its aggregate gross assets do not exceed $50 million.  To be considered a “qualified” corporation, it must be a C-corporation other than a (1) DISC; (2) a regulated investment company; (3) a real estate investment trust; (4) a real estate mortgage investment conduit; (5) a financial asset securitization investment trust; (6) a cooperative; or (7) a corporation electing the Puerto Rico and possessions tax credit.   

        More limitations are written into the code section, including the requirement that the corporation use at least 80% by value of its assets in the active conduct of a qualified trade or business.  While the requirements may seem overwhelming, entrepreneurs seeking funds now have an excellent marketing tool to entice investors.  And for investors, this might be the incentive to finally write that check.  President Obama estimated that the measure would drive “capital to as many as one million small firms across America.”  President Obama might be right about this excellent benefit.