Watch Out For Zero Capital Gains Promises

It's challenging for startup entrepreneurs to raise equity capital for their companies, so just about any time there is federal legislation that motivates private individuals (or "angels") to invest in job creating young companies I'm for it.

There is a little known provision of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 which provides certain investors a considerable incentive to purchase qualifying stock in small businesses.

The law provides for an unprecedented 0% tax rate on capital gains up to $10 million or 10 times the investment amount. The law also removes most gains from Alternative Minimum Tax (AMT) obligations, which is the IRS' tricky way of collecting extra taxes from many business owners, the upper middle class and high income earning Americans.

My problem with the legislation is that it's more of a perk for a limited few rather than the equally well-deserving many.

Here are some fine points of the legislation.

  • Timing. The investment must be made before December 31, 2011 and purchased directly from the corporation. I would not assume that this tax break will be renewed in 2012 so business owners should start fundraising now to allow investors plenty of time to complete due diligence.
  • C corporations only. The investment must be in a standard C corporation, not an S corporation, Limited Liability Company and of course a sole proprietorship. Most startup businesses are organized as anything but a C corporation.
  • Small matters. Corporations can't have more than $50 million in assets to qualify for the tax break.
  • Investment time frame. In general, the stock must be held by the individual or partnership investor for at least five years, which matches the amount of time most business owners need to develop, test and commercialize new products and services. At last, someone was thinking in Washington!
  • Investment purpose. At least 80% of the corporation's assets must be used to conduct research or operate the business. This is not an unreasonable hurdle; however I disagree with the strict limitations on industries that might qualify for the tax break. In general, restaurant, hospitality, real estate, finance and many service businesses may not be able to offer this tax-saving reward to their new investors. Before assuming that your business won't qualify, do some added research. A service business in certain types of Internet, advanced health care or education enrichment services might qualify.

With stubborn unemployment and anemic growth, wouldn't Washington want to make the most effective private enterprise building initiatives available to more rather than less? If you agree that zero capital gains tax breaks for private investors should not end at the end of 2011 and should be available to more business owners, write your congressional representatives now!

Susan Schreter is a 20-year veteran of the venture finance community, MBA-level educator and policy advocate for small business owners. Her work is dedicated to improving startup operating performance with reduced personal risk to entrepreneurs. She is the founder of www.takecommand.org, which offers the largest centralized database of regional and national small business funding sources in the U.S., including angel clubs, micro-finance lenders, venture capital funds and more. Follow Susan on Twitter @TakeCommand

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