Legislative Update Affecting Sm. Businesses

As I am sure you are aware, there has been a significant amount of uncertainty as to the effect of various provisions of the United States tax code due to the prolonged congressional negotiations associated with the fiscal cliff. However, with President Obama’s recent signature on the American Taxpayer Relief Act of 2012 (“ATRA”), the so-called ‘fiscal cliff’ bill, we now have some certainty.

In particular, ATRA Section 324 has extended through the end of 2013 a valuable tax benefit available to non-corporate investors in certain qualified small business stock under Internal Revenue Code (“IRC”) Section 1202. Under ATRA Section 324 and IRC Section 1202, a non-corporate taxpayer can exclude from gross income 100% of the eligible gains from the sale or exchange of qualified small business stock that was originally issued to the taxpayer after September 27, 2010 but before January 1, 2014 and that was held for at least 5 years. The effect of ATRA Section 324 is to extend a tax benefit under the Creating Small Business Jobs Act of 2010 that had previously expired on January 1, 2012.

What this means is that taxpayers who meet the requirements of IRC Section 1202 can enjoy tax-free gains on the future sale or exchange of their qualified small business stock.

In order to meet the requirements of IRC Section 1202, a non-corporate taxpayer must be the original issuee of qualified small business stock and hold the stock for more than 5 years. If those requirements are met, eligible gains for qualified small business stock acquired between September 27, 2010 and January 1, 2014 are fully excludable from gross income, and thus not subject to income tax.

Under IRC Section 1202, qualified small business stock is stock in a C corporation whose aggregate gross assets do not exceed $50,000,000. The stock must be acquired by the taxpayer at its original issue in exchange for money, property (excluding other stock), or services. The issuing corporation must utilize at least 80% of its assets in the active conduct of one or more businesses (excluding certain professional trades, such as health, law, engineering, accounting, financial services, banking, hospitality, etc.). And there are limits on the issuing corporation’s redemption of stock (from both the taxpayer and other stockholders) which may disqualify stock in some cases from this favorable tax treatment.

Also, under IRC Section 1202 eligible gain is typically gain up to $10,000,000 on the disposition of stock held for more than 5 years. The $10,000,000 maximum gain is a lifetime maximum per taxpayer (shared by married couples whether filing jointly or separately) per issuing corporation.

Thus, as an example, an interested investor could in 2013 purchase significant amounts of newly-issued stock from a qualifying small business (a C corporation with aggregate gross assets of less than $50,000,000) and enjoy up to $10,000,000 in tax-free gain on the sale or exchange of that stock in 2018 and beyond.

If you have questions about ATRA Section 324 or IRC Section 1202, and whether they may apply to you individually or to current or potential investors in your fundraising efforts, please do not hesitate to contact Ryan Lowe with questions.

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