On September 27, 2010, President Obama signed into law the Small Business Jobs Act of 2010, which includes several provisions aimed at helping small businesses. Among these provisions is a temporary amendment to Section 1202 of the Internal Revenue Code of 1986, as amended (the “Code”), which permits the potential exclusion of 100 percent of a non-corporate taxpayer’s gain from the sale of qualified small business stock (“QSBS”) acquired after September 27, 2010 and before January 1, 2011, and which is held for more than five years. The exclusion applies for purposes of both the regular federal income tax and the alternative minimum tax, which is a significant departure from prior law, which allowed only a 50 percent exclusion (or 75 percent in the case of QSBS purchased after February 17, 2009 and prior to January 1, 2011) and treated a portion of the excluded gain as a preference item for purposes of the alternative minimum tax.
In general, QSBS is stock that is acquired (i) at original issuance by a non-corporate taxpayer in exchange for property or services; and (ii) with respect to a “C corporation” that conducts a “qualified small business.” A “qualified small business” cannot have aggregate gross assets in excess of $50 million (at any time prior to or immediately following the issuance of its stock), and must also satisfy an “active business requirement.” The “active business requirement” is satisfied if the corporation uses at least 80 percent of its assets, measured by value, in the active conduct of one or more “qualified trades or businesses.” For this purpose, the statute provides a non-exclusive list of businesses that do not constitute a “qualified trade or business,” including a professional service business, an oil and gas production or extraction business, a banking, financing, leasing or investing business, a hotel, motel or real estate rental business, or similar businesses.
In addition to the above requirements, the exclusion set forth in Code Section 1202 is also subject to the following additional general limitations:
- the QSBS must be held for at least five (5) years prior to its disposition; and
- the aggregate gain that can be excluded by any single taxpayer with respect to QSBS held with respect to a particular issuer is generally limited to the greater of either (i) $10 million or (ii) ten times the aggregate adjusted bases of the QSBS held by the taxpayer.
For purposes of the exclusion calculation described in the second bullet point above, it is important to note that if QSBS is acquired in exchange for property, then the adjusted basis of such QSBS will generally be no less than the fair market value of the property contributed (regardless of the taxpayer’s actual cost basis in such property).
As a result of the new temporary amendments to Code Section 1202 , investing in a qualified small business has the potential to deliver significant tax incentives to non-corporate taxpayers and investors. However, because the benefits are only available with respect to QSBS investments made by the end of 2010, non-corporate taxpayers need to act quickly. Readers of this alert should feel free to contact one of the attorneys listed in the margin to discuss the recent amendments to Code Section 1202 and how such amendments might potentially apply to their own individual facts and circumstances.