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Golden Opportunity for Investors & Entrepreneurs; Qualified Small Business Stock

Golden Opportunity for Investors & Entrepreneurs; Qualified Small Business Stock 

While congress fusses over a 3% change in tax rates, some business investors could score a 100% tax break…..but they need to hurry! 

Since the August 10, 1993, investors in Qualified Small Business Stock (QSBS) could exclude half the gain on the sale of this stock if it was held for more than 5 years……up to $10 million or 10 times cost basis (whichever is greater)!   QSB’s (described later in this article) are certain businesses formed after August, 1993 having less than $50 million in total assets.  Over the years, portions of the excluded gain were subject to Alternative Minimum Tax (AMT), thus few sellers of this stock received the potentially huge tax savings which one should expect if excluding $10 million or more from income.  Over the years we have assisted founders and “Angel” or “family and friend” investors plan for these gains which usually occur when a company is sold or goes public.  That darn AMT always gets in the way! 

This is huge!  For a scant 95 day period commencing September 28, 2010 and ending December 31, 2010, those who invest in QSBS and hold that stock for five years may exclude 100% of the gain up to $10 million, or 10x investment and the AMT does not apply!  This was buried in the latest stimulus package.  I think it was probably a political favor for someone; 95 days is hardly enough time to meaningfully stimulate significant investment in small companies! It’s not even being publicized! 

I recall when Alice Cooper and David Bowie packaged their copyrights in companies they took public.  They made a fortune!  If I thought my garage band had commercial potential, I’d incorporate before year end to take advantage of this tax windfall!! 

Seriously, this is a phenomenal opportunity!  Inventors, R & D companies and others with a new idea or product should consider setting up a new qualifying corporation before the end of the year.  Likewise, Angel investors and others, willing to invest in high risk investments like start ups and small businesses should seriously consider closing a deal by 12-31-10!  It also appears that employees of qualified small business corporations could exercise stock options and take delivery of the stock certificates by year end. It doesn’t have to be a new company, just one formed after August 10, 1993 which is issuing stock directly to the investor after September 27, 2010 and before December 31, 2010.  Individuals and, under certain circumstances, LLC’s, Partnerships and S Corporations are eligible shareholders. 

My mind has been grinding on this ever since I saw it for creative ways to utilize this opportunity.  One that came to mind is a business which will eventually be sold as a business unit verses an asset sale.  If you have a qualifying small business that is going to pass to the next generation or, perhaps be sold to employees or competitors, and that business is presently an LLC, partnership or sole proprietorship, consider incorporating and recapitalizing that business, issuing stock before December 31,2010.  

These are extremely complex transactions.  If you want to take advantage of this once in a lifetime opportunity and have identified a deal, talk to your tax professional soon.  You will need most of the days remaining in the year to complete the deal…which is why this looks more like a political favor than tax stimulus to me!  This article together with the requirements of a QSB, and an illustration is posted on our website.  Follow this link to the article on our website: Golden Opportunity for QSB Investment

Two unprecedented tax planning opportunities for 2010

To:  All our Blogging Friends

From:  Paul M. Polito, CPA

Subject:  Two unprecedented tax planning opportunities for 2010

  1. Conversions of Retirement accounts to Roth IRA Accounts: 

I was recently asked to speak to a group of investors regarding Roth Conversions.  To prepare for the presentation I enlisted the help of our team to develop several financial and tax models to look at the economics for a 30 year age range.  To my surprise, with few exceptions, the investor was better off converting their retirement account to a Roth IRA than retaining their traditional tax-deferred retirement account.  Most of our clients could not make Roth contributions in the past because of a limitation based on Gross Income.  It was simply too low to work for most clients.  The gross income limit on Roth conversions is lifted effective in 2010. 

For those of you who are not familiar with Roth IRA accounts, these accounts are provide for non-deductible contributions, but the earnings inside the Roth account are never taxed; that means never taxed! 

Roth conversions are particularly attractive now that the estate tax is reinstated effective January 1, 2011.  If you pass away with a tax deferred retirement account (Qualified Plan, 401k, 403b, Traditional IRA, Simple IRA, etc.), the retirement account is includable in your taxable estate and your heirs pay tax on the income as they receive it.  The after tax yield to the ultimate beneficiary can be under 20% of the account value at death. 

We posted the hand outs for my presentation on our website which include financial models illustrating the after-tax benefits of Roth Conversions.  The greatest opportunity for a Roth Conversion is between now and December 31, 2010 because you have the option to pay the tax on the conversion in 2010 or split the conversion income between 2011 and 2012.  There is also the opportunity to use hindsight if the Roth account should decline in value to “recharacterize” the account back to a normal retirement account and avoid the tax.  If this is of interst to you, I suggest you call your tax professional before Thanksgiving to allow sufficient time.  See the article on our website with this link: Roth IRA Conversions.

2.  Exclusion of up to $10 million in capital gain on certain small business stock:

Effective September 27, 2010 through December 31, 2010 (a 95 day period) if you invest in a qualified small business as defined in the statute, and you hold the stock for at least five years, you can exclude up to $10 million from capital gain and, (and this is huge!) the exclusion is not subject to Alternative Minimum Tax!  This was part of a stimulus package but at a mere 95 days, it seems more like someone received a political favor!  If you have the opportunity to invest in a small business that qualifies, or, if you start a small business that qualifies, this could be the opportunity to save up to $2.8 million in tax.  This is ideal for start ups, Angel Investors, employees with opportunities to buy qualifying company stock, etc.  Also, if a family business is currently owned in an LLC or other non-corporate entity and there are plans to sell to the next generation, this could be a golden opportunity to reduce the tax cost of a transfer.  The rules are actually pretty generous.  Call your tax professionals for more information if this is of interest to you right away.  It takes time to set these plans and investments in motion.


In my 6-3-10 blog post I identified potential problems with some estate plans if a spouse should pass away in 2010.  The crux of the problem lies in trust language that is designed to transfer the maximum exempt amount to an irrevocable Decedent’s Trust upon the death of the first spouse.  While this strategy worked well in 2009, it could be disastrous in 2010.  This article illustrates two examples of these which are too voluminous for a blog post. 

Click here for the full article.

2010 Estate Tax Pitfall

In 2001, Congress passed an act that temporarily eliminated the estate tax for the year 2010.  None of us who practice in this arena ever thought that Congress would allow this one year “repeal” to stand. Towards the end of 2009, both houses passed bills reinstate the tax, but nothing ever became law.  While this sounds great, danger lurks within previously drafted estate documents.

I have been very concerned about the impact of this on our middle class clients.  What would happen, I thought, if someone passed away in 2010 with estate planning documents designed around the pre-2010 law?  After all, no one ever expected the 2010 estate tax repeal to actually go into effect.

Earlier this year, my fears were born out.  Jack and Jill were in their 80’s.  They lived on rents from some valuable rental properties they have owned for over 40 years.

Their trust was designed to put the maximum amount of the estate (up to $3.5 million in 2009) about 75% of their estate, into a Decedent’s Trust upon the first death.  This way, when one of them (Jack or Jill) passed away; the real estate would have stepped up to fair market value on the date of death. Assuming Jill died in 2009 or 2011, more depreciation could be deducted and, if the property was sold soon after the death, there would have been no estate tax and no tax on a capital gain.  Translation – the heirs could have sold the property at fair market value and paid little or no tax if Jill passed away in 2009 or 2011.

When Jill died in 2010, following the provisions of their trust, here’s what is supposed to happen:

1)      The maximum amount exempt from estate tax goes into the decedent’s trust.  In 2010, that means everything.

2)      Jack’s estate cannot take advantage of the step up in basis when he passes away after 2010 because all his assets have been distributed out of his estate to the Decedent’s Trust.  Thus, if the heirs sell the property out of the Decedent’s Trust, the taxable gain will be about $3.2 million!

What can we learn from this?

It is June and Congress has not acted on this.  It is probably a good idea if you or someone you know owns highly appreciated property to have an emergency 2010 provision added to the estate planning documents.  Also, if there is a complex estate with different beneficiaries of the various sub-trusts, a “2010 Fix” is probably needed.

For a “primer” on estate planning, read the article “Estate Tax.”  Always contact a professional experienced in this area of practice if you need assistance.

Opportunities and Pitfalls in Organizing a New Business

Recently we received a call from an attorney incorporating a start up. 

His question was simple enough:  “I need to know how to quantify beginning capital for this corporation I formed on December 31, 2009; there is cash and IP (Intellectual Property) involved.”

Upon learning the facts, we determined the people that formed this corporation were about to step into a taxable event of over $3 million!  We were glad we got the call before it was too late!

The lesson to be learned here is that it is always a good idea to get expert advice when forming a new company.  It can be very complicated!  Believe it or not one of the first things to consider is the ultimate exit strategy.  Frequently exit strategy drives the decision regarding both the form and tax options of the new entity in formation.

For small businesses engaged in a “trade or business” there is an exit strategy benefit worth planning for: 

Shareholders of Corporations formed after 2/17/09 and before 1/1/2011 get a 75% exclusion from capital gains up to $10 million.  Previously this was 50% and at that rate it saved a ton of tax!  The corporation must be a C corp. from inception.  If you want to use this strategy but still pass the initial losses to the founders, start with an LLC and form the corporation when you get traction and investors.  If you hold the stock for 5 years before sale, you get the exclusion.  There are details and  limitations that are beyond this discussion.

When forming an entity with sweat equity and money, “sweaters“  beware !

If the money partner puts in property (and/or money) of $1 million and the “sweaters” put in labor for 50% equity, they realize taxable earned income of $1 million upon receipt of the stock.   Usually the money partners want “know how” or other  I.P.  If this situation fits, turn your “sweat” into “property”  before you receive stock.  You could save a fortune!   Written business plans, patents, laptops….all property!  Work for your equity……. Taxable! 

If the money partner puts in $1 million for 50% and the “sweaters” put in labor for 50%, they realize income of $1million upon receipt of the stock.  This can be devastating to starving start ups.


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