Extended opportunity
to exclude gain from
qualified small-biz stock
taxstrategy
By GEorGE G. JonEs and Mark a. LuscoMBE
Section
1202
requires
patience:
It will
take at
least five
years to
see how
the story
ends.
“
”
As the economy picks up to yield- reduced investment risk, and as an increase in tax rates continues to
threaten, the benefits of Section 1202 qualified small-business stock deserve some attention. From both the perspective of the investor seeking to maximize after-tax yields and
the entrepreneur seeking additional capital,
the 2010 Tax Relief Act’s extension of the 100
percent exclusion of gain from Section 1202
stock for an additional year, through Dec.
31, 2011, is an opportunity worth revisiting.
What remains constant under any second
look, however, is that Section 1202 requires
patience: It will take a taxpayer at least five
years to see how the story ends after any particular acquisition of qualified stock.
As Section 1202 now exists, the 100 percent
exclusion of gain from the sale or exchange
of qualified small-business stock by a noncorporate taxpayer applies to qualified small-business stock acquired after Sept. 27, 2010,
and before Jan. 1, 2012, and held for more
than five years. While the Obama Administration’s F Y 2012 budget proposes making the
100 percent rate permanent, most insiders
don’t see this happening at this time. Given
that prediction, less than seven months remain until Dec. 31, 2011, rolls around and
presents a likely last chance to acquire stock
that will qualify for the 100 percent rate.
generally applies (for stock issued by a corporation in an empowerment zone, a 60 percent
exclusion applies, except to gain attributable
to periods after Dec. 31, 2014).
For purposes of the 50, 60 or 75 percent exclusion, gain excluded under the small-business stock provision is not used in computing
the taxpayer’s long-term capital gain or loss,
and it is not investment income for purposes
of the investment interest limitation. As a result, the taxable portion of the gain is taxed at
present at a maximum rate of 28 percent under Code Section 1(h). That twist, of course,
is not an issue when 100 percent of the gain
is excluded under Section 1202.
Unlike the 50, 60 or 75 percent exclusion,
too, the 100 percent exclusion is unique in
allowing it to apply for both regular and Alternative Minimum Tax purposes. Under the
lower exclusions, a portion of the excluded
gain is subject to AMT.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA,
is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
PERCENTAGE OF GAIN EXCLUDED
To encourage investment in small businesses
and specialized small-business investment
companies, Code Sec. 1202(a) allows a tax-
payer (other than a corporation) to exclude
from gross income a certain percentage of
the gain realized from the sale or exchange of
qualified small-business stock held for more
than five years. That percentage depends
upon the date that stock is acquired:
For stock acquired after Sept. 27, 2010,
and before Jan. 1, 2012, a 100 percent exclu-
sion applies.
For stock acquired after Feb. 17, 2009,
and before Sept. 28, 2010, a 75 percent exclusion applies.
For stock acquired before Feb. 18, 2009,
or after Dec. 31, 2011, a 50 percent exclusion
GROSS ASSETS TEST
A qualified small-business corporation’s aggregate gross assets cannot exceed $50 million either before the issuance of the stock
or immediately thereafter. Immediately after
the issue date, the $50 million cap must take
into account any amounts received for the
stock on its issuance. If at any time before the
issuance, but on or after Aug. 10, 1993, the
corporation or any predecessor held gross
assets exceeding $50 million, the stock will
not qualify.
Gross assets for purposes of the $50 million
cap include cash plus the aggregate adjusted
bases of all other corporate property. Adjusted basis for this purpose is determined as if
the basis immediately after the contribution
were equal to the property’s fair market value
on the contribution date.
Although qualification of issued stock is
not dependent upon keeping under the $50
million asset ceiling subsequent to its issu-
ance, the test will disqualify any subsequently
issued stock once the $50 million ceiling is
reached. For businesses close to the $50 mil-
lion mark looking to issue further qualified
stock, managing cash flow and expenses
should become a priority. This might espe-
cially be the case in certain research and
development operations that realize signifi-
cantly greater expenses than income over an
extended period of time.
PER-ISSUER LIMITATION
On the investor side of Section 1202, shareholders should be aware of their own limit
on the amount of gain that is eligible for the
exclusion. There is a cumulative limit on the
gain from any one issuer that a taxpayer may
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