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House To Consider Bill Eliminating Capital Gains Taxes On Small Business Investments As Early As This Week

As reported in the Wall Street Journal, the House may consider as early as Thursday a bill that would temporarily eliminate capital gains taxes on qualified small business stock held for more than 5 years, in an attempt to drive investment capital toward small businesses that qualify as qualified small businesses under Section 1202 of the Internal Revenue Code. 

The bill would only open the window for the 100% exclusion for qualifying investments made between March 15, 2010 and before January 1, 2012. It seems unlikely, given the length of time it takes for startup companies to raise money, and for investors to make investment decisions in startups, that a window of opportunity this short will do anything other than bestow the benefit on parties who would already have been likely to make investments in startup companies during this period.

My suggestions to improve the bill:

  • Congress should consider the securities law aspects associated with investments in startups. For the most part, this tax benefit is only going to be available to "accredited investors," the same group Congress wants to tax more heavily in other instances. Congress ought to make the securities law exemptions broader and more available to a greater group of people. For example, everyone (although this would run contrary to the Dodd bill, which would narrow the group of people who qualify as "accredited investors").
  • If Congress's desire is to drive capital into businesses that it perceives are creating jobs, it ought to make this tax exclusion permanent.
  • If Congress really wants to drive capital into businesses that it perceives are creating jobs, why not, instead of a capital gains exclusion available after 5 years, allow investments in these companies to be deducted in the year in which the investment is made? (Right now, investors who buy stock can't recover the basis in their investment until they sell their stock; if you buy equipment, you can deduct that either all at once or over a fairly short period of time. In other words, the tax code heavily favors investments in equipment over investments in stock.)
  • Or even better, give investors a dollar-for-dollar tax credit for their investments?
  • Or even better, give investors a dollar-for-dollar tax credit for money paid to employ people in any job?

What would Secretary Newco say? What would Glenn Kelman say? I think I know what @cdixon would say. What would Michael Arrington say?

The exclusion is summarized by the Ways and Means Committee as follows:

100% Exclusion of small business capital gains. Under current law, Section 1202 provides a fifty-percent (50%) exclusion for gain from the sale of certain small business stock that is held for more than five years. The amount of gain eligible for the Section 1202 exclusion is limited to the greater of 10 times the taxpayer’s basis in the stock, or $10 million gain from stock in that small business corporation. This provision is limited to individual investments and not the investments of a corporation. The non-excluded portion of section 1202 gain is taxed at the lesser of ordinary income rates or 28 percent, instead of the lower capital gains rates for individuals. The American Reinvestment and Recovery Act (the “Recovery Act”) temporarily increased the Section 1202 exclusion to seventy-five percent (75%) for qualifying stock acquired in 2009 and 2010. The bill would temporarily increase the amount of the exclusion to one hundred percent (100%) for qualifying stock acquired after March 15, 2010 and before January 1, 2012. This provision is estimated to cost $1.962 billion over 10 years.

More information on this bill is available at the Ways and Means Committee web site.

The opinions expressed here are my own.

Reposted from Davis Wright Tremaine's Start Up Company Blog:


Copyright © 2020, Davis Wright Tremaine LLP, All Rights Reserved.National Law Review, Volume , Number 165



About this Author

Joseph Wallin, Davis Wright Tremaine, Corporate finance attorney

Joe Wallin focuses on significant business transactions, corporate finance, venture capital, mergers and acquisitions, and tax law. His work includes angel and venture financings, drafting and negotiating mergers and acquisitions agreements, joint venture agreements, and advising businesses and individual clients regarding tax planning and equity compensation. Joe represents foreign investors in U.S. businesses, provides general counsel services for companies from startup to post-public, and advises clients in Securities Exchange Act compliance and corporate governance. Joe is a...