The 1202 Planning OpportunityBy http://profile.typepad.com/1237764140s22740 // January 8, 2013 in Emerging Companies, Startup Law 101, Taxes
A partial answer may be that there is nothing outrageous or scandalous about the QSB exclusion. Whereas the tax breaks in the fiscal cliff legislation for Hollywood movie production, for electric scooter manufacturing, for NASCAR race tracks, and the like, are laughable, or tragic, or both, and so more fun to talk about. (See for example this entertaining piece by Brad Plumer in the Washington Post, From NASCAR to rum, the 10 weirdest parts of the ‘fiscal cliff’ bill.)
A better answer may be that the exclusion for QSB stock is so difficult to explain.
Here's a paragraph from a post Joe wrote in the summer of 2010, summarizing what QSB stock is:
In general, 'qualified small business stock' is stock in a C corporation acquired by a taxpayer at its original issue if as of the date of issuance such corporation was a 'qualified small business,' and during substantially all of the taxpayer’s holding period for such stock, the corporation met certain active business requirements and was a C corporation. A 'qualified small business' in general means a business with less than $50 million in gross assets. The active business requirements require that at least 80 percent (by value) of the assets of the corporation be used by the corporation in the active conduct of 1 or more 'qualified trades or businesses.'
Much to chew on there, and you must also slog through the analysis of whether or not you are dealing with one of the "qualified trades or businesses."
Get those fundamentals settled, and you're still not done: you have to hold the stock for 5 years. And the exclusion from capital gains tax applies *only* to your initial $10 million in gain.
Among the planning opportunities this fiscal cliff tax benefit affords:
- A chance to weigh whether a C corp makes more sense for the structure of your new business than an LLC or other alternatives;
- Whether you should convert your LLC into a C corp before the benefit expires at the end of 2013;
- From the investor perspective, whether you can negotiate reps and covenants in your investment documents to give you and others in the deal a fair shot at meeting the requirements of the exclusion; and
- From the perspective of an employee, whether you should exercise a stock option in a timely way.
This is complicated stuff. Even if you master the rules in the abstract, you are likely to yet need advice from a good accountant and/or a tax lawyer. But it may be worth the effort.
Here are some references to help us all get (re)started (caution, all of these were prepared in the context of the exclusion in prior incarnations):
- QUALIFIED SMALL BUSINESS STOCK - TAX ALERT, by Asher Bearman, from The Venture Alley in October 2010.
- SECTION 1202 QUALIFIED SMALL BUSINESS STOCK (pdf), by David B. Strong, a Morrison Foerster white paper from August 2011 hanging out on the open web.
- IF YOU ARE AN LLC, CONSIDER BECOMING A C CORPORATION BEFORE YEAR END, by Joe Wallin, from his Startup Law Blog in October 2010.
- A comment from lawyer George Grellas on Hacker News from 2010, with an overview of the subject, including the provocative point that founder shares can potentially qualify.
Photo: Tom Magliery / Flickr.