How do the qualified small business stock provisions work?
The qualified small business stock provisions have a short fuse and limited applicability, but there are significant advantages for investment in small business stock. The new law increases the benefits of investing in qualified small business stock.
For investments in qualified small business stock post September 2010 and before January 1, 2011, 100 percent of any resulting gain on such stock is excluded from taxation if held for five years. Under the new law, the excluded gain will not generate AMT tax.
Acquired shares must be newly issued shares of a C corporation, not an S corporation, and held until at least 2015.
To be eligible for the exclusion, the individual must generally acquire the small business stock at its original issue (directly or through an underwriter) for money, for property other than stock, or as compensation for services. When the stock is issued, the aggregate gross assets of the issuing corporation may not exceed $50 million. In addition, the corporation also must use at least 80 percent of the value of its assets in the active conduct of one or more qualified trades or businesses.
The amount of gain eligible for the 100 percent exclusion by an individual with respect to any corporation is capped at the greater of 10 times the taxpayer’s basis in the stock, or $10 million.
Are there any other provisions to watch out for?
A C corporation that converts to an S corporation will generally incur federal income taxes on sales of its appreciated assets held at the date of conversion for a period extending 10 years following the conversion. Previous legislation had reduced this holding period to seven years for dispositions during 2009 and 2010.
The new law further shortens the holding period to five years beginning in 2011.
The new law raises the deduction limit for startup expense from $5,000 to $10,000 and increases the phaseout threshold to $60,000 for one year, 2010. Startup expenses are costs related to creating an active trade or business, or investigating the creation or acquisition of an active trade or business.
The increase is viewed as an incentive to investigate and create new businesses.
What tax provisions are expiring at the end of the year?
Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the individual marginal income tax rates were 15, 28, 31, 36 and 39.6 percent. EGTRRA gradually reduced the individual marginal income tax to 15, 25, 28, 33 and 35 percent, with a phase-in of rates at 10 percent.
Absent intervening legislation, effective for tax years beginning after Dec. 31, 2010, marginal tax rates will revert to 15, 28, 31, 36 and 39.6 percent. These rate hikes are in addition to the 0.9 percent Medicare tax on earned income above $200,000 ($250,000 for married couples filing a joint return) and a 3.8 percent Medicare tax on the lesser of the individual’s net investment income for the tax year or modified AGI in excess of $200,000 ($250,000 for married couples filing a joint return).
In addition to the increase in tax rates, the phaseout limitations for personal exemptions (both AMT and regular tax) and itemized deductions will return to previous limitation amounts, effectively reducing the benefit of such deductions.
WALTER M. McGRAIL, JD, CPA, is a senior manager at Cendrowski Selecky PC. Reach him at (248) 540-5760 or [email protected].