Wallin

Todd

Joe Wallin and Brian Todd: President Obama has proposed eliminating the capital gains tax on qualified small business stock. This has been a theme of the President’s for some time, but perhaps significantly he reiterated it in his State of the Union Speech last night. Again, he doesn’t quit.

As startup company and tax lawyers, we believe that eliminating the capital gains tax on qualified small business stock held for more than five years would create a literal flood of investments into startup companies, which would create jobs and future prosperity.

Why? Because reducing the capital tax rate to zero makes investing in startups tax free, and investors like tax favored investments. And a zero capital gains tax rate is an absolutely screaming deal.

The only way to make investing in startups more attractive would be to give taxpayers a tax credit for amounts invested in startups, but that would cause an immediate drain on tax receipts.

The Presidents’ proposal simply foregoes future tax revenues on startup company investment successes—and this is a good idea because startups that succeed create a lot of jobs and other revenue for the government.

We anticipate that if the President’s proposals become law we will see in the startup investment community a super intensified focus and interest in businesses that will qualify for this benefit.

Which businesses will qualify? Most of the technology startup companies formed in Seattle as C corporations could qualify. To name a few of the categories that will generally qualify: software companies, web 2.0 companies, internet companies, and medical device companies.

The limitations?

--Corporate taxpayers don’t qualify for the benefit.

--There is a cap on the gain eligible for exclusion equal to the greater of 10x the taxpayer’s basis in the stock issued by the corporation and disposed of during the year or $10 million reduced by gain excluded in prior years on dispositions of the corporation’s stock.

--The business can’t have more than $50 million in gross assets, including the proceeds from the stock sale at the time of the issuance of the stock.

--The corporation issuing the stock has to be involved in an active trade or business, and certain types of businesses don’t qualify.

--You have to hold the stock for 5 years before you sell (but there is a rollover benefit under Section 1045, which works much like the 1031 exchange benefit for real estate).

You can read more about these requirements at page 17 of the Obama Administration’s Fiscal Year 2010 Revenue Proposals.

Joe Wallin and Brian Todd are partners in the Seattle law firm Davis Wright Tremaine. Wallin focuses on emerging growth companies, while Todd chairs the firm's tax practice. Opinions expressed in guest posts are those of their authors, and don't necessarily reflect the views of TechFlash or its staff. Have an idea for a guest post of your own? Email us: techflashtips@bizjournals.com