Qualified small business stock: an opportunity for tech startups.

• Author: McGuire, Brad

Technology companies, in particular biotech, face large hurdles in raising capital to sustain operations until they have a viable product in a marketplace. As a result, their capitalization schedules are unlike those of other types of businesses where capital is provided once at startup and operations are funded from sales or services that are made or delivered soon after organization. The existence of convertible debt, incentive stock options, warrants, and preferred stock, along with the need for additional capital, creates opportunities to issue additional qualified small business stock (QSBS) in 2013. The benefit of the QSBS gain exclusion is enhanced with the increase in capital gain rates that went into effect in 2013.

QSBS issued after Aug. 10, 1993, and before Feb. 18, 2009, was eligible for a 50% exclusion from capital gains; however, the balance was subject to the 28% capital gain rate. The alternative minimum tax (AMT) also came into play to further reduce the small benefit derived from the exclusion. This limited benefit also reduced the effort that practitioners put into planning around Sec. 1202. That changed with the enactment of the American Recovery and Reinvestment Act of 2009 (ARRA), P.L. 111-5. ARRA increased the exclusion rate from 50% to 75%, but retained the 28% rate on the remainder, as well as the alternative minimum taxable income adjustment. The 75% exclusion is effective for stock acquired from Feb. 18, 2009, through Sept. 27, 2010. This gave practitioners more incentive to begin exploring opportunities, but the exclusion was still limited, still had AMT implications, and required a stock sale to take advantage of the tax benefit.

On Sept. 28, 2010, the Small Business Jobs Act of 2010, P.L. 111-240, increased the exclusion to 100% for both regular and AMT purposes but only for stock issued prior to Dec. 31, 2010. The 100% exclusion was then extended on Dec. 17, 2010, by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312, through Dec. 31, 2011. The 100% exclusion provision expired on Dec. 31, 2011, but it was restored retroactively by the American Taxpayer Relief Act of 2012, P.L. 112-240, which was signed into law on Jan. 2, 2013. The extension is temporary through Dec. 31, 2013.

The history of this provision has not allowed much time for tax practitioners to maximize its use. With the provision set to expire again on Dec. 31, 2013, now is the time to work with...