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Fiscal Cliff Legislation Extends Tax Incentive to Invest in Small Businesses

As a result of the recent “fiscal cliff” legislation, otherwise known as the American Taxpayer Relief Act of 2012 (2012 Tax Act), many individual investors are expecting future tax increases, either in the form of higher capital gains tax on their investment profits or higher income taxes on their salaries. The good news though is that the 2012 Tax Act extended a special tax incentive for investors who purchase stock in certain small businesses (Qualified Small Businesses as described below).

The Qualified Small Businesses tax incentive1 now provides that investors who have purchased stock in Qualified Small Businesses after September 27, 2010 but before January 1, 2014 are entitled to exclude 100% of their capital gains on the sale or exchange of such small business stock if such stock is held for five years or more, subject to certain limitations on the small business and the investor’s gain as discussed below.2

Generally, to be a Qualified Small Business, the business must (a) be a domestic C-corporation; (b) have gross assets not in excess of $50,000,000 (at all times since August 10, 1993, as well as immediately after the issuance of the stock); and (c) use more than 80% of its assets in the active conduct of a qualified trade or business (excluding certain businesses in the legal, banking, insurance, investing, farming and hospitality industries) during the time the taxpayer holds such stock.

The maximum gain an investor can exclude pursuant to this incentive (with respect to a particular corporation) is the greater of (a) 10 times the taxpayer’s basis in the stock, and (b) $10,000,000, minus the gain taken in prior years in connection with the same Qualified Small Business.

While we applaud Congress’s initiative, we believe it would have created a greater incentive for investors if Congress decreased the holding period of the small business stock from five to two years. Nonetheless, given this significant exclusion on capital gains, investors and entrepreneurs should keep this incentive in mind when considering their tax strategies and investment opportunities for the coming year.

1 26 U.S.C. 1202.

2 Qualified Small Business Stock purchased before September 27, 2010 may qualify for an exclusion but not a 100% exclusion.

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About this Author

Daniel I. DeWolf, Mintz Levin, Emerging Companies Lawyer, Venture Capitalism

Daniel is Co-chair of the firm’s Venture Capital & Emerging Companies Practice. In addition to his active legal practice, he is an adjunct professor of law at the NYU Law School and he has a wealth of experience in private equity and venture capital, having co-founded Dawntreader Ventures, an early stage venture capital firm based in New York.

Daniel's practice focuses on representing emerging technology companies, venture capital, private equity, sports and entertainment, corporate governance, and general corporate law.

Before joining Mintz Levin, Daniel was head of...

Evan M. Bienstock, Corporate, Securities Attorney, Mintz Levin Law Firm

Evan’s practice involves all aspects of corporate and securities law for emerging growth, early stage and start-up companies in the digital media, energy and clean technology, sustainability and life sciences industries. He routinely advises clients on their growth and development and participates in a diverse array of transactions, from private placements of securities to mergers and acquisitions. He also counsels his clients on their daily corporate needs and has extensive experience assisting companies with compliance to federal and state securities laws.

Evan’s corporate finance experience includes the completion of hundreds of venture capital and private equity financings, representing both the funds providing the capital and the companies seeking funding. He has been involved in the formation and financing of energy and clean technology companies in renewable markets, such as wind, coal, water turbines, waste treatment, and biofuels and regularly represents start-ups emerging from incubators, accelerators, laboratories and co-working spaces. 

Evan is deeply involved in the start-up community in New York City and regularly advises and mentors young companies and entrepreneurs on an array of legal and business issues that they face.

He is an avid sailor.

Samuel Effron, Securities Law Attorney, Mintz Levin, Capital Financing Lawyer

Sam’s practice focuses on general corporate representation, securities law matters, and transactional work, including public and private offerings, mergers and acquisitions, venture capital financings, debt and venture capital fund formation, federal securities law compliance and reporting, and corporate governance matters.

He has provided counsel to a diverse range of public and private companies, both domestic and foreign, in a variety of industries, including video gaming, consumer electronics, media, e-commerce, software and high technology, education, marketing, financial...