With the recent signing of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Congress extended for one year the 100 percent exclusion from federal income tax for sales of qualified small business stock. This provision (1) allows taxpayers to pay no federal income tax on up to $10 million in gain from the sale of qualified small business stock and (2) eliminates the full amount of the excluded gains as a tax preference item for alternative minimum tax purposes. The exclusion, previously set to expire on December 31, 2010, will now expire on December 31, 2011.

The exclusion generally applies to stock of a domestic C corporation meeting certain requirements. In order to qualify, the stock must be held for at least five years prior to sale and must be purchased by the investor upon original issuance from the corporation (directly or through an underwriter) in exchange for money or other property (generally not for other stock) or as compensation for services. Also, the issuer corporation generally must use 80 percent of its assets (by value) in a qualifying active business for substantially all of the stockholder's holding period. A qualifying active business excludes financial institutions, farms, professional service firms, hotels and restaurants among others. Furthermore, the aggregate gross assets (generally defined as cash plus the aggregate adjusted tax basis of other property) held by the corporation must not exceed $50 million at any time before or immediately following the investment by the investor, including amounts received by the small business from the investor. Other requirements and special rules apply in certain situations.

The extension will allow venture capital investors and capital-seeking companies a longer time to negotiate and complete financings, especially where tax considerations for investors may be of importance. Further, for entrepreneurs considering a new venture, the extension may make it attractive to start a venture during this period, as the venture's founder stock would then be eligible for the exclusion.