100% Exclusion for Qualified Small Business Stock To Be Extended

Big news: On December 16, 2014, the Senate passed H.R. 5771, the Tax Increase Prevention Act of 2014. The bill now goes to the President. He is expected to sign it.

The bill would do a variety of things, but from a startup perspective one important thing it would do is renew the 100% exclusion from tax for gain on qualified small business stock received from qualifying C corporations during the calendar year 2014.

Qualified Small Business Stock

The 100% exclusion expired at the end of 2013. This bill renews the 100% exclusion for stock issued by qualifying C corporations issued before the end of 2014.

Thus, if:

  1. You received founder shares in a C corporation in 2014, or
  2. You invested in shares of a C corporation in 2014, and
  3. You hold those shares for 5 years,
  4. You may be able to exclude up to $10M in gain from the sale of those shares.
  5. There are a variety of other limitations that apply to the Section 1202 qualified small business stock benefit. For example, the corporation issuing the shares has to, among other things, be a “qualified small business,” have less than $50M in gross assets, have an active business, and be engaged in a qualified trade or business.

The Text of the Extension

1202

This 100% exclusion affects your choice of entity considerations significantly. Only C corporations can issue qualified small business stock. Thus, if you form an S corporation, your founder shares cannot qualify for the 100% exclusion.

The Cap on the Benefit

The 100% is not uncapped, but you can exclude up to $10M under Section 1202.

limitation

In Conclusion

This extension is good news for the startup world.

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  • J.R.

    I did a *very* quick search and could not find a financial analysis of which corporation structure is better upon a successful exit, an LLC or C corp under this new law. The C corp experiences double taxation for any dividends paid and pays the corporate tax rate. The LLC does not have double taxation but commonly disburses an amount equal to the highest personal tax rate to owners to cover their tax liabilities and pays a capital gain upon exit. Also, the LLC allows the members to put losses on their tax returns.

    If anyone finds a good analysis, please post a URL. This might make a big difference. As an additional bonus, securities offerings might be simpler with a C corp.

  • http://startuplawblog.com/joewallin Joe Wallin

    Well, if you are an LLC taxed as a partnership, and your “exit” is a part stock/part cash deal, an LLC cannot participate in a tax free reorg under 368. So, this argues toward corp over S or C corp.