January 18, 2011
Tax
100% Exclusion From Tax for Stock
Issued in 2011 by Certain Qualified Small
and Middle Market Businesses
For an update to this topic, see our alert, "Exclusion from Tax for Stock Issued by Qualified Small
Business Corporations," available here.
On November 3, 2010, we issued a client alert (the “Prior Alert”) discussing a unique opportunity
provided by the Small Business Jobs Act of 2010 (P.L. 111-240) with respect to so-called “qualified
small business stock.” The temporary change in the tax law allowed individuals, estates and trusts
to acquire (directly or indirectly through flow-thru entities described in the Prior Alert) qualified
small business stock between September 28, 2010 and December 31, 2010 that, subject to certain
caps, limitations and a minimum five-year holding period, could be sold without the post-acquisition
gain being subject to tax.
Congress recently extended this opportunity for another year. Now, eligible shareholders are able to
acquire tax-exempt (or near tax-exempt) qualified small business stock until January 1, 2012.
Accordingly, this alert is intended to be read in conjunction with, and as a supplement to, the Prior
Alert.
This special treatment may affect many common business transactions during 2011, including the
following:
1. Raising New Capital. The temporary extension of the increase in the exclusion percentage
from 50% to 100% (see below) is intended to be an incentive to “qualified small business”
corporations (those not having assets with a combined gross value of over $50 million on the
date of the stock’s issuance or at any other time after August 10, 1993 and excluding certain
types of businesses described in the Prior Alert) to raise new equity capital before the end of
2011.
2. Purchasing or Selling a Qualified Small Business or Stock in a Qualified Small Business.
Although generally only the first purchaser of stock that is issued by a qualified small
business (i.e., stock purchased directly from the issuing corporation and not stock purchased
from another shareholder) is entitled to exclude all or part of his or her gain on the sale of the
stock, it may be possible to structure the purchase and sale of a qualified small business in a
way that allows the purchaser(s) to acquire “original issue” stock as required by the statute.
The ability to acquire a company or an interest in a company in such a manner likely will
motivate parties contemplating such a transaction to complete it before 2012.
3. Flow-Thru Conversions. Companies currently organized as partnerships and other flow-thru
entities may elect to take advantage of this opportunity to convert (by election or otherwise)
to C corporation status to allow the future appreciation in the company’s ownership interests
to become eligible for the 100% gain exclusion for qualified small business stock acquired
during 2011. See the Prior Alert discussion of this topic.
The favorable tax attributes of qualified small business stock also should be kept in mind when stock
of a C corporation is transferred, including understanding:
(i) Tax-deferred transfers of stock may cause the stock to lose its status as qualified
small business stock eligible for gain exclusion when it ultimately is sold in a taxable
transaction;
(ii) The gain from the sale of the stock may be eligible for tax-free, roll-over treatment
with respect to the purchase of other qualified small business stock (2011 would be a
good time for a rollover, as the appreciation in the new qualified small business stock
will be subject to the 100% gain exclusion instead of the temporarily suspended 50%
exclusion); and
(iii) The ability to exclude some or all of the gain from tax when the stock is sold after
the five-year holding period.
The exclusion percentages for qualified small business stock issued over the last 18 years and held
for more than five years are as follows:
(a) 50% for qualified small business stock (60% on pre-2017 appreciation in the value of
certain empowerment zone business stock) issued/acquired between August 11, 1993
through February 17, 2009 (with the non-excluded portion of the gain being subject to a
maximum 28% rate of tax and a percentage of the excluded portion being a tax preference
item subject to alternative minimum tax);
(b) 75% for qualified small business stock issued/acquired between February 18, 2009
through September 27, 2010 (with the non-excluded portion of the gain being subject to a
maximum 28% rate of tax and a percentage of the excluded portion being a tax preference
item subject to alternative minimum tax);
(c) 100% for qualified small business stock issued/acquired between September 28, 2010
through December 31, 2010 (with no portion of the excluded gain being an alternative
minimum tax preference item);
(d) 100% for qualified small business stock issued/acquired between January 1, 2011 through
December 31, 2011 (with no portion of the excluded gain being an alternative minimum tax
preference item); and
(e) For qualified small business stock issued/acquired after December 31, 2011, the rules
return to those described in (a) above. The alternative minimum tax preference item
percentage for gain excluded under Section 1202 (other than qualified small business stock
issued after September 27, 2010 and before January 1, 2012, for which no portion of the
excluded gain is a preference item) is determined based on when the stock is purchased and
sold. It is:
(i) 7% for stock sold (whether for cash or in a taxable exchange) in a taxable
year beginning before 2013;
(ii) 42% for stock acquired before January 1, 2001, and sold in a taxable year
beginning after 2012; and
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(iii) 28% for stock acquired after December 31, 2000 and sold in a taxable year
beginning after 2012.
Congress’ extension to the end of 2011 of the time for persons (other than C corporations) making
what is tantamount to a tax-exempt, or largely tax-exempt, investment (or reorganizing a taxable
investment into a largely tax-exempt investment) in certain small and middle market companies
provides many unique tax-planning opportunities that should not be overlooked or neglected. We
welcome inquiries into exploring the planning opportunities that may exist in particular situations.
******************
Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you
that any U.S. federal tax advice contained in this communication (including any attachments) is not
intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under
the Internal Revenue Code of 1986, as amended or (ii) promoting, marketing or recommending to
another party any transaction or matter addressed within.
Warren P. Kean
warren.kean@klgates.com
P +1.704.331.7413
Roger S. Wise
roger.wise@klgates.com
P +1.202.778.9023
Thomas F. Joyce
thomas.joyce@klgates.com
P +1.312.807.4323
Charles H. Purcell
charles.purcell@klgates.com
P +1.206.370.8369
J. Stephen Barge
steve.barge@klgates.com
P +1.412.355.8330
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