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Temporary Exclusion for 100% of Gain from Qualified Small Business Stock Acquired by Year End

William Whitledge of Goodwin Procter LLP

On September 27, 2010, President Obama signed into law the Small Business Jobs and Credit Act of 2010 (the "SJBCA"), which includes a temporary exclusion for 100% of the gain recognized by non-corporate investors from the sale of qualified small business stock ("QSBS") acquired after September 27, 2010 and before January 1, 2011.

The exclusion applies for purposes of both the regular federal income tax and the alternative minimum tax, thus potentially reducing the federal income tax on qualifying gain to zero. This is a significant departure from current law, which provides for only a 50% exclusion (75% for QSBS purchased in 2009 or 2010 prior to enactment of the SJBCA) and treats a portion of the excluded gain as a preference item for purposes of the alternative minimum tax.

Under the new provision, as under current law, the aggregate amount of gain with respect to an investment in a single issuer that may qualify for the exclusion is generally limited to the greater of $10 million or 10 times the investor's aggregate tax basis in the issuer's QSBS. In addition, a number of requirements must be satisfied in order to qualify for the exclusion (whether under the new provision or current law). Certain of the key requirements are as follows:

  • Subject to certain exceptions, the investor must acquire the stock at original issuance, generally for money or other property (not including stock)
  • The investor must hold the stock for more than five years
  • The issuer must be a "qualified small business" on the date the QSBS is issued, which generally requires, among other things, the issuer to be a domestic C corporation with gross assets of $50 million or less immediately after the issuance and at all times since August 10, 1993
  • For substantially all of the investor's holding period, the issuer must be engaged in a "qualified trade or business" or certain research and experimental activities, and must not have engaged in significant redemptions at certain times before and after the issuance

Investors considering taking advantage of the new exclusion should carefully consider the foregoing requirements and the additional requirements that may apply to them under the Internal Revenue Code. In particular, as discussed above, investors should note that an investment in QSBS must be closed prior to January 1, 2011 in order to qualify for the temporary 100% exclusion under the SJBCA.

William Whitledge, Partner, wwhitledge@goodwinprocter.com

William Whitledge, a partner in and chair of the firm's Tax Practice, specializes in corporate, partnership, foreign and general business taxation. Mr. Whitledge spends a substantial amount of time structuring international and domestic business transactions, including mergers, acquisitions, financings, dispositions, reorganizations and other business restructurings, and venture capital investments. He also has extensive experience in structuring collective investment vehicles with tax-exempt, foreign and domestic investors, including RICs, REITs and pension investments from an unrelated business taxable income perspective.

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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Goodwin Procter LLP. All rights reserved.