On Sept. 13, 2021, the House Ways and Means Committee released 881 pages of legislative text laying out its budget reconciliation proposals. It also issued an 18-page section-by-section summary of the proposals.
These proposals will be marked up in committee and are not set in stone, but if enacted in their present form they would raise more than $2 trillion in revenue over 10 years, according to a report issued by the Joint Committee on Taxation.
Our focus here is on the proposal to modify the rules relating to qualified small business stock (QSBS).
QSBS generally
Section 1202 generally provides for the full or partial exclusion of capital gain realized on the sale of QSBS. If the requirements are met, then taxpayers can exclude from gross income capital gain in an amount equal to the greater of (i) $10 million, or (ii) an annual exclusion of 10 times their basis in the stock sold (for an exclusion amount up to $500 million). Both of these limitations apply on a per-issuer and per-taxpayer basis, and while the rules limit the exclusion to the greater of the two rules, in practice, the $10 million rule is most often the limiting factor in start-up ventures.
The exclusion percentage depends on the date when the taxpayer acquired the QSBS from the issuer, rather than the date on which the stock is sold.
- For QSBS acquired after Aug. 10, 1993, and before Feb.18, 2009, the exclusion percentage is 50% of the amount of realized gain.
- For QSBS acquired after Feb. 17, 2009, and before Sept. 28, 2010, the exclusion percentage is 75% of the amount of realized gain.
- For QSBS acquired after Sept. 27, 2010, the exclusion percentage is 100% of the amount of realized gain.
House proposal
The proposal regarding QSBS, outlined in section 138150 of the legislative text, would raise $5.718 billion over 10 years. It would deny the 75% and 100% exclusion percentages to taxpayers whose adjusted gross income equals or exceeds $400,000, but it would not deny section 1202 benefits entirely. It would allow such taxpayers to take advantage of the 50% exclusion for QSBS.
Importantly, the proposal would be retroactive to sales or exchanges occurring on or after Sept.13, 2021, subject to a binding contract exception. Under that exception, the proposal would not apply to any sale or exchange that is made under a written binding contract that was in effect on Sept. 12, 2021 (and not modified in any material respect thereafter).
If you are in the process of selling QSBS under circumstances where you could be impacted by this proposal, you should reach out to your tax advisor before taking any further action. It is important to understand what can be done and what should not be done if you want to preserve the 75% or 100% exclusion rates under this proposal, assuming it is enacted in its present form.
Even if the 75% and 100% exclusion percentages do not apply, other planning considerations may still apply, such as stacking and packing.
Learn more information on QSBS FAQ’s for Founders podcast.
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Daniel Mayo, principal, JD, LLM, has more than 20 years of professional tax experience as well as experience in federal, international and financial products taxation. He is a member of Withum’s National Tax Services Group and oversees the U.S. Federal income tax research, planning and review functions. He can be reached at dmayo@withum.com.