Congress Extends Temporary Provisions of Small Business Act

The Small Business Jobs and Credit Act of 2010 (the Act) was signed into law by President Obama on Sept. 27, 2010. The Act includes a temporary exclusion for 100 percent of any gain recognized on the sale of qualified small business stock (QSBS) acquired after Sept. 27, 2010, and before Jan. 1, 2011. In addition, during this period, the excluded gain is not treated as a preference item for purposes of Alternative Minimum Tax, although other limitations may apply. This change results in a potentially significant federal income tax benefit to non-corporate investors, essentially reducing to zero the federal tax rate for capital gain on QSBS to which the change applies. Investors originally had until Dec. 31, 2010, to take advantage of this tax benefit.   The deadline for such investments to be eligible to receive favorable tax treatment is now Dec. 31, 2011.

Non-corporate investors with existing nominal exercise price warrants or options (or that otherwise have the opportunity to increase their ownership in a portfolio company) should carefully consider the tax benefits of making an additional investment before the end of the year.

Overview

QSBS may only be issued by a "qualified small business" and under Section 1202 of the Internal Revenue Code of 1986, as amended (the "Code"), the issuer of the stock needs to comply with the following requirements:

· Be a domestic C corporation;

· Have aggregate gross assets of $50 million or less immediately after the issuance and at all times since Aug. 10, 1993; and

· Agree to submit such reports to the Internal Revenue Service (IRS) and its stockholders as the IRS may require.

Section 1202 of the Code also requires that the issued stock meet the following requirements:

· The investor must not be a corporation;

· The QSBS must be originally issued to the investor (no purchases from existing stockholders);

· For substantially all of the investor's holding period, the issuer must be engaged in a "qualified trade or business" (which generally excludes service corporations) or certain research and experimental activities;

· The issuer may not redeem more than a de minimis number of shares from investors to which the QSBS is issued within a four year period that begins two years prior to the issuance of the QSBS;

· No "significant redemptions" of the issuer’s stock from any stockholder may occur during the two-year period beginning one year prior to the QSBS's issuance; and

· The QSBS must be held for more than five years.

If the requirements set forth above for the qualified small business and QSBS are satisfied, the tax benefits of Section 1202 of the Code apply, subject to satisfaction of all other technical requirements. The amount of gain that can be excluded by a single investor with respect to the particular issuer is generally limited to the greater of $10 million or 10 times the investor's adjusted tax basis in the issuer's QSBS.

If you are interested in exploring the availability of the tax benefits provided under Code Section 1202 or have questions about the information set forth in this article, please contact Kristine Danz or any of the other attorneys in Ice Miller's Business Group or Tax Group.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.

Nov. 15, 2010 (Updated Dec. 2010)