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Bar News - February 15, 2017


Tax Law: Certain Small Business Stock Can Be Sold Tax-Free

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Shareholders who sell stock that qualifies as small business stock are eligible to exclude between 50 and 100 percent of all or a portion of the gain from the sale. This could represent a significant tax savings for qualifying business founders and investors. The gain that can be excluded is limited to the greater of $10 million or 10 times the shareholder’s basis in the qualified small business stock.

To be eligible for the exclusion, the stock has to be issued by a “qualified small business,” and the shareholder must have held the stock for more than five years and purchased it at its original issue for either cash or other property, or received it as compensation for services provided to such business. The exclusion is not available for qualified small business stock owned by a corporation.

A “qualified small business” is a domestic “C” corporation that issued its stock after Aug. 10, 1993, provided that its total aggregate gross assets did not exceed $50 million at any time from Aug. 10, 1993, to the date of the stock issuance and immediately after the stock issuance.

Only stock in an “active” business that is engaged in a “qualified trade or business” is eligible for the exclusion. A business is considered an “active” business if during substantially all of the time period of the shareholder’s ownership of the stock, the business devotes at least 80 percent (by value) of its assets in the active conduct of one or more qualified trades or businesses.

A “qualified trade or business” is any trade or business other than 1) one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees; 2) any banking, insurance, financing, leasing, investing, or similar business; 3) any farming business (including the business of raising or harvesting trees); 4) certain businesses eligible for depletion deductions; and 5) any business of operating a hotel, motel, restaurant, or similar business.” Certain types of corporations such as regulated investment companies, real estate investment trusts, and real estate mortgage investment conduits are also excluded from the definition of a qualified small business.

A “qualified small business” is also limited in the amount of real estate it may own and the amount of stock in non-affiliated companies it can own in order to meet the active business requirement. An investment company generally only qualifies as a small business under this exclusion if it is a specialized small business investment company under section 301(d) of the Small Business Investment Act of 1958 (as in effect on May 13, 1993).

The percent of gain excluded from income ranges from 50 percent to 100 percent, depending on when the eligible stock was acquired. Stock acquired on or before Feb. 17, 2009, is eligible for a 50 percent exclusion. Stock acquired after that date and before Sept. 28, 2010, is eligible for a 75 percent exclusion. Stock acquired after Sept. 27, 2010, is eligible for a 100 percent exclusion.


Peter Beach

Peter Beach is head of the Tax Department at Sheehan Phinney. His practice covers a broad range of federal, international, state and local tax matters, including mergers and acquisitions, workouts, corporate and pass-through entity taxation and tax-exempt organizations.

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