Time is Running Out on Capital-Gains Tax Relief for Small Company Investments

Temporary tax relief under the Small Business Jobs Act of 2010 is still available for certain investments made in small companies on or before December 31, 2010.  More specifically, an investor can receive a total capital-gains exclusion in connection with the sale of qualified small business stock (“QSBS”) that is purchased before the upcoming year-end and held for more than five years before the eventual sale transaction.  The amount of the capital-gains exclusion is limited, however, to the greater of (i) ten times the QSBS investment or (ii) $10 million.  Unlike past tax incentives for small company investment, this latest opportunity for capital-gains tax relief will not trigger the alternative minimum tax.

Below are certain key points to consider if you intend to take advantage of this tax relief before the end of 2010:

1.  Only non-corporate taxpayers, such as individuals, trusts and estates, can take advantage of the tax relief;

2.  Investors will need to act quickly, because the QSBS must be purchased on or before December 31, 2010; and

3.  QSBS has, among others, the following general requirements:

• QSBS generally is stock of a domestic C corporation;
• Gross assets of the issuing domestic corporation cannot exceed $50 million (even following the issuance of the QSBS);
• The QSBS must be originally issued to the investor in exchange for money or other property (but not other stock) or as compensation for services; and
• During the stock holding period, at least 80% of the corporation’s assets must be used in the active conduct of one or more qualified trades or businesses (which generally will include most early stage technology companies, but will not include, for example, restaurants, hotels or professional activities such as medicine or law).

While it may be a challenge to initiate, negotiate and complete a more complex angel or venture capital financing with less than 45 days before the start of 2011, there still may be good opportunities for some companies to structure and complete seed round financings or other investments where the parties are motivated to negotiate and finalize an investment quickly.

 Other ways to take advantage of this tax relief opportunity include the conversion of outstanding debt into equity, additional equity investment in the stock of a qualifying corporation and/or the exercise of stock options or warrants.  Lastly, if you are sitting on the fence considering that new startup venture, then you could take advantage of this tax relief window by forming the new corporation and issuing the founder stock before year-end.