New Federal Law: Zero Taxes on Gains on Small Business Investments
Last week, President Obama signed the Small Business Jobs Act of 2010, which includes several benefits for small businesses and also a benefit for angel investors. We want to get this information out to you, as this benefit relates to investments made between September 27 and December 31, 2010 and may be of interest to many of you.
The new law includes a 100 percent exemption for gains made in Qualified Small Business Stock, and this new bill effectively means that you pay no taxes on gains from your investments that meet several criteria below and Alternative Minimum Tax does not apply.
If you are interested in this program, PLEASE TALK TO YOUR ACCOUNTANT to ensure you have all the information you need to structure your investments to meet all requirements.
Criteria and Limitations:
- Investments must be made by a non-corporate investor (for example, individuals or funds structured as LLCs).
- Investments must be made between September 27 and December 31, 2010 to qualify for no taxes on the gains.
- The company in which you invest must be a C corporation and must be a qualifying type of business (many businesses except financial institutions, farms, professional service firms, hotels, and restaurants)
- The company in which you invest must not exceed $50 million in aggregate gross assets at any time before the investment or immediately afterward. An important issue in this size is that 80% of the assets must be used in the "active conduct" of the business at all times.
- The stock must be purchased by the investor as an original issuance from the corporation, directly or through an underwriter. So, notes and warrants do not count. We're hearing that if you have an outstanding note that converts to stock before December 31st, then the stock would count for this program. (BUT TALK TO YOUR ACCOUNTANT.)
- The stock must be held for more than five years (subject to exemptions for qualifying tax-free rollovers)
- There are limitations on redeeming shares of the company's stock before and after the qualified stock is issued.
- The gains eligible for the zero taxes by any single taxpayer max out at $10 million or ten times the adjusted tax basis of stock issued by the stock
- For just investments made between September 27 and December 31, 2010, the gains are also not subject to the Alternative Minimum Tax.
Other Important Things to Know:
It's confusing, but Qualified Small Business Stock (QSBS) taxes are actually based on ordinary income rather than what we normally think of as capital gains taxes. So, when you see that QSBS provides a 100% exemption of taxes on gains, the comparison is to the current 75% exemption on gains - which works out to 7% rate on ordinary income.
For any of you or your accountants looking for the actual language to the bill, we link you to the Small Business Jobs Act of 2010 here. The relevant sections are 2011-2013 (pages 51-53).
Here are a few of the articles and backgrounders we liked on the subject:
- Wall Street Journal - For New Tax Breaks, Act Fast , September 30, 2010
- Calling All Angels - Donald Jay Korn, Financial Planning Magazine, September, 2009 (This was written when the exemptions for QSBS were only 50 to 75%, but has helpful information, and includes one of the last media quotes from Luis Villalobos.)
- Favorable Legislation Relating to Qualified Small Business Stock, Latham & Watkins, September 27, 2010
- Overall summary of other items in the Small Business Jobs Acts
Several of the members of the advisory council of attorneys and accountants who advise ACA's Public Policy Committee are working on client alerts. As we have those, we will post them on our Web site and otherwise get the information to you.
Angel Capital Association