Who wouldn’t like paying NO federal tax on capital gains income? Well, here’s a way you can do it…
If you are a currently a small business owner ($50M and below in assets), investor or employee, or you consult with these entities, a unique opportunity may exist to call upon investors, employees and others in order to raise additional capital. Stock acquired after September 27, 2011 and before January 1, 2012 that is held for 5 years and then sold may be afforded a 0% rate with respect to capital gains. In addition, this gain is also excluded from the alternative minimum tax calculation.
If a venture capital or private equity is looking to issue additional stock in existing portfolio companies or form a new Company there are a number of considerations that should be taken into account. Previous communications have summarized the general rules as outlined: http://www.eisneramper.com/Small-Business-Stock-Rules-1210.aspx. Note, however, that the law has been extended to allow stock acquired through December 31, 2011 to qualify for these favorable rules. These rules are particularly attractive because the favorable tax treatment will attaches to any shares issued in accordance with these rules even if the value of the Company continues to increase.
Some additional factors to consider when seeking to take advantage of these rules include ensuring the Company has been a C Corporation at all times after August 9, 1993, before the stock was issued and immediately after the stock is issued. In forming a new Company it would be important to organize the Company as a C Corporation due to the fact that S Corporation stock does not qualify. The Company must also be a C Corporation throughout a substantial duration of the shareholder’s holding period in order to qualify zero percent rate. Unfortunately, no guidance has been provided regarding what constitutes a “substantial” duration.
The assets of the Company must be used in an active trade or business. Therefore, those companies formed with assets involved in passive investment activities will generally not qualify if those assets constitute greater than 20% of the value of the Company’s assets. Included within costs that qualify are start-up costs, research and development expenditures and rights to computer software which produce active business computer software royalties. No more than 10% of the value of the Company’s assets may consist of stock or securities of other corporations which are not subsidiaries of the corporation. This does not include assets that are expected to be sold within a two year period in order to meet working capital requirements. More than 10% of the Company’s assets must not be comprised of real property not used in the active conduct of a qualified business.
The taxpayer must generally have acquired the stock at its original issue, either in return for cash, property or services. The amount of the gain which may qualify is limited to the greater of $10 Million ($5 Million for those taxpayers married filing separately) or ten times the taxpayer’s adjusted basis in the stock per year for each individual or married couple (i.e. if a person owns stock in more than one Qualified Small Business they are entitled to the $10M with respect to each company).
Please note that this information is intended as a brief summary of the rules and regulations regarding Qualified Small Business Stock and does not represent a complete overview of the Internal Revenue Code rules and regulations.
If you would like to take advantage of this opportunity, please consult with your EisnerAmper engagement team.