
Tell HN: 100% exemption for angel investors extended through 2011 - idive
http://thomas.loc.gov/cgi-bin/query/F?c111:5:./temp/~c111oasqlH:e89693:
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grellas
My two cents (check with a good CPA or tax lawyer to make sure, as my
specialty is not tax law, though I generally have a good working knowledge of
the subject - be ready to get bleary-eyed, though, this is _tax_ , and think
of it as a basic overview only):

For years (since 1993), section 1202 of the U.S. tax code has provided a
_partial_ exclusion of gain realized on the sale of "qualified small business
stock" (QSB stock) that is held for more than 5 years.

The big glitches under the law as it has heretofore existed: (a) the exclusion
was only partial (for many years, only 50% but higher for qualifying stock
acquired in 2009 and in 2010 prior to September 27); and (b) a portion of any
gain that was so excluded had to be added back as a preference for AMT
purposes. Thus, this exclusion had more limited value over the years that it
has now, during this current window.

The benefit of a "section 1202 exclusion" today is that 100% of the gain
realized is excluded (subject to a cap as discussed below) and the exclusion
applies for purposes of both the regular federal income tax and the
alternative minimum tax.

Thus, if a taxpayer today acquires qualifying QSB stock, holds it for more
than 5 years, and then sells it at a gain, the gain on that sale will be
completely free of federal income tax.

Who is a qualified buyer of such stock? The exclusion may be claimed by any
"taxpayer" who meets the statutory requirements. It is not limited to
"investors" but includes anyone who buys stock in a qualifying corporation and
otherwise meets the section-1202 tests. This _would_ include founders.

The exclusion may _not_ be claimed if the taxpayer is a corporation. However,
and this is important for VCs, angel groups and others who might be organized
as some form of partnership, the gain from the disposition of qualified small
business stock by a partnership, an S corporation, or certain trusts that is
taken into account by a partner, shareholder or participant in such entity
_is_ eligible for section-1202 exclusion if (a) all requirements of section
1202 are otherwise met, and (b) the partner, shareholder or other participant
held his interest in the entity on the date the QSB stock was acquired and at
all times thereafter until the stock's disposition. Bottom line on this piece:
corporations can't benefit from a 1202 exclusion but some entities can - check
with a competent tax adviser on this - as can individual investors and
founders.

A "qualified small business" under section 1202 is a domestic C corporation.
An S corporation will not qualify; nor will an LLC.

In addition, to be a "qualified small business," the gross assets of the
entity through the date of the issuance of the stock in question cannot have
exceeded $50 million without regard to liabilities.

The business must also be an "active business" - that is, it cannot be an
investment company (entities will fail this test if more than 10% of the value
of their net assets consists of stock or securities, other than those of a
subsidiary, and will similarly fail if more than 10% of their assets consist
of real property that is not used in the active conduct of a qualified trade
or business).

Concerning such "qualified small businesses," then, what is "qualified small
business stock"?

This can be _any_ stock in a domestic C corporation. Not preferred stock only,
as might be purchased by outside investors. It is _any_ stock, including
common stock that is purchased by founders and others in a typical startup.

It must be stock that is "originally issued" to the taxpayer during the
applicable time period (in this case, on or after September 27, 2010 through
the date of expiration of the window for 100% exclusion). This means newly
issued from the corporation. It can't be bought in a resale deal. Nor can the
corporation and the taxpayer play games by trading equivalents (e.g., by
redeeming x amount of stock from the taxpayer and then issuing it again to
him); thus, it is not QSB stock if the corporation purchases any such stock
from the shareholder/taxpayer within two years before or after the issuance of
the shares for which the exclusion is sought. Section 1202 treatment will also
be denied if, within one year before or after the issuance, the corporation
redeems more than 5% of the aggregate value of all its stock as measured at
the beginning of such period (certain redemptions, such as on death, are
disregarded for this purpose).

Finally, to qualify as QSB stock, the stock must be acquired by the taxpayer
in exchange for money or other property (not including stock) or as
compensation for services provided to the corporation (this was the rule
historically under section 1202 but please confirm with a good CPA or tax
lawyer to make sure this carries forward during the 100% exclusion window - I
think it does but am not 100% sure - to be safe, pay cash). Nothing in the
rules specifies that the amount paid has to exceed any particular sum and so
the amounts typically contributed by founders should generally qualify.

The 1202 exclusion is capped. Specifically, a taxpayer can exclude qualifying
gain up to the limit of the _greater of_ $10 million or 10 times the
taxpayer's basis in the stock. Even more, this is measured "per issuer,"
meaning that someone who holds QSB stock in multiple, unrelated entities and
otherwise meets the rules in each case would be able to exclude a potentially
very large amount of gain if multiple entities proved to be success cases.

To sum up: if you as a non-corporate taxpayer acquire QSB stock during this
window and hold it for more than 5 years, you will be able to realize
substantial gains on the eventual sale of any such stock free of federal
income tax.

Now, this is a very complex tax area and so you should definitely check with a
competent tax professional before making important decisions here. That said,
from the narrow view of startup founders and investors (and setting aside
public policy concerns about the wisdom of this sort of legislation), this is
a pretty amazing opportunity for those who have plan to invest or build out
their ventures for the long term. With a whole year to plan for it (assuming
this is finalized as anticipated), many interesting possibilities exist. Think
of the above as suggestive, of things to consider in weighing options for such
planning.

~~~
rdl
Please let me know which (if any) charity you would like me to donate to -- I
earlier was looking for a lawyer to look into this and the applicibility for
founder shares. A year extension is a bonus.

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andrewljohnson
I talked about this with my investors and my lawyer (I'm lucky enough to have
Grellas counsel me).

If you are like my company, and you have some small amount of convertible
debt, and you are ramen-profitable but don't have a valuation, there are many
reasons why this may not be worthwhile.

I'll leave it to Grellas to explain... note that this was prior to the
extension of the law:

 _The “qualifying small business” (QSB) stock rules let anyone who invests in
qualifying stock (meaning stock in a C corp) by December 31 of this year, and
who subsequently holds such stock for at least 5 years, avoid any capital
gains tax and also any AMT on the eventual sale of that stock..._

 _... Pricing the stock also has implications for the grant of future equity
incentives to other key people and so you need to consider not only pricing
but also issues such as having to do a 409A valuation the next time you grant
options to anyone in the company._

 _... The company would need to authorize their conversion in the absence of a
qualified funding and will need to authorize a form of preferred stock into
which they can convert. It is possible, of course, to have the notes convert
into common stock but this puts a very high value on the common and makes it
difficult to grant future incentive stock to key people without pricing it at
a high level (the law allows as much as a 5 to 1 pricing differential between
preferred and common and so, if preferred stock is used instead of common, you
can still make future incentive grants at 1/5th the price of the preferred)._

This led me to conclude that it's not worthwhile to convert, and George
confirmed:

 _I think it is marginal for the company and its noteholders at this point and
makes sense only if there is a fairly strong sense that people will hold for 5
more years. It would inject at least several thousand in costs (at least $10K,
with some $5K to $7K out of pocket as a lump sum, if a 409A appraisal should
be needed to price option grants and the like) and would add tax complications
in terms of stock pricing in the short term – and so, yes, I would say you
should likely skip it._

That said, if you are looking to invest in a great start-up and this tax break
is meaningful to you, shoot me an email, and I'll send you my pitch :)

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idive
Unfortunately, I still haven't been able to get a straight answer on how this
applies to founders (versus investors). What about co-founders contributing
time or IP instead of cash?

Previous discussion here: <http://news.ycombinator.com/item?id=1972515> and
<http://news.ycombinator.com/item?id=1555363> and probably several others

~~~
janj
I met with George Grellas at Grellas & Associates yesterday about exactly
this, it's potentially a huge benefit for founders, I believe it does require
some small cash amount along with IP. I am in the process of creating an
entity through Grellas & Associates and was going to pay extra to have the
process expedited to take advantage of this tax benefit that I believed
expired at the end of this month. Can someone please confirm that this has
been extended through 2011 or provide a link? I haven't been able to find
anything.

~~~
Multiplayer
Here is a link to a PDF summary. Now just waiting for the President to sign
it.
[http://tax.cchgroup.com/downloads/files/pdfs/legislation/bus...](http://tax.cchgroup.com/downloads/files/pdfs/legislation/bush-
taxcuts.pdf)

I have spent a lot of time on this over the past few weeks. I'm amazed at how
few CPA's actually understand this legislation.

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sabj
FYI, Thomas searches time out after 30 min; can you give a direct cite to the
congressional record or a permalink? (Click Share/Save, e.g.,
"<http://hdl.loc.gov/loc.uscongress/legislation.111hr4259>)

Good news, but yeah, would love to see exactly the bill that you are referring
to. Thanks!

~~~
idive
HR4853, section 760

<http://tinyurl.com/2fc9ore>

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anigbrowl
FYI, links to Thomas are dynamic and die after about 20 minutes - OP or mod
should update with a permalink to this (final version of the bill, no partisan
content): <http://democrats.senate.gov/pdfs/MAT10785.pdf> The party link is
only because Harry Reid is still majority leader and it was up there first.

Not a lawyer or accountant, but a _very_ quick look says
partnership/s-corp/homeowner (ha!) capital gains taxed at 0% extended 2 years
if bought before end 2012, realized before end 2016. Options would count, I
believe, but ask an expert. 100% exclusion from taxable income from startup
investments made in 2011, but must be configured as an LLC. Also, mortgage
interest and first-time homebuyer tax credits extended one more year. Some
employment-based tax credits extended too, which might help fledgling startups
a little.

It's _lot_ of money just in terms of the tax incentives, as well as various
benefit extensions and so on...from a financial planning standpoint it's like
stimulus 2.0, $958 billion of red ink. Some economists are saying it's worth
0.5-1% more GDP growth next year. I worry it may be fiscal madness, but
perhaps I'll be eating my words in 2 years' time.

~~~
gojomo
_...must be configured as an LLC._

That sounds exactly backwards from the previous (through 2010-12-31)
exemption, and Grellas' discussion of what a 'qualified small business' is
above. Typo?

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oziumjinx
Any idea if this includes an employee exercising options (paying for them)?

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wac6
George, awesome post. Another suggestive possibility, to borrow from your
astute way of phrasing, may be for stock option holders to weigh exercising
the vested portions of their options prior to January 1, 2012. Such date being
the new date that the exclusion expires, as I understand is provided in the
law the President signed today.

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idive
Sorry for the expired link. I don't appear able to edit it, but it's Section
760 of HR4853 (aka the big tax compromise bill that's been in the news). It
was signed into law today.

Here's the text: <http://tinyurl.com/2fc9ore> (section 760) But there's not
much to it.

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wnm106
Official link to the extension:

[http://www.gpo.gov/fdsys/pkg/BILLS-111hr4853enr/pdf/BILLS-11...](http://www.gpo.gov/fdsys/pkg/BILLS-111hr4853enr/pdf/BILLS-111hr4853enr.pdf)

SEC. 760. TEMPORARY EXCLUSION OF 100 PERCENT OF GAIN ON CERTAIN SMALL BUSINESS
STOCK. (a) IN GENERAL.—Paragraph (4) of section 1202(a) is amended— (1) by
striking ‘‘January 1, 2011’’ and inserting ‘‘January 1, 2012’’, and (2) by
inserting ‘‘AND 2011’’ after ‘‘2010’’ in the heading thereof. (b) EFFECTIVE
DATE.—The amendments made by this section shall apply to stock acquired after
December 31, 2010

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geekinthecorner
Now if we could just get rid of Regulation D and make the accredited investors
requirement sane enough that your average engineer could be allowed the
opportunity to invest in the companies we believe in.

