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Tax Relief for Small Business

Eliminate Taxation of Capital Gains on Qualified Small Business Stock

The Omnibus Budget Reconciliation Act of 1993 allowed noncorporate taxpayers to exclude a portion of the capital gain on qualified small business stock from tax if the stock is held for at least five years. In general, 50 percent of the gain is excluded (60 percent for certain businesses in empowerment zones); the remaining gain is taxed at a maximum rate of 28 percent. The 2009 stimulus bill (the American Recovery and Reinvestment Act) raised the exclusion to 75 percent for stock acquired after February 17, 2009, and before January 1, 2011. The Small Business Jobs Act again raised the exclusion, to 100 percent, for stock acquired after September 27, 2010, and before January 1, 2011. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extended the 100 percent exclusion to stock acquired before January 1, 2012.

The maximum gain eligible for the exclusion is limited to the greater of $10 million ($5 million for married taxpayers filing separately) less any gain reported on prior tax returns, or 10 times the taxpayer’s cost basis (purchase price plus fees).

For stock acquired before September 28, 2010 or after December 31, 2011, a portion of the excluded gain is an AMT preference item (that is, it is added to the AMT measure of income and thus subject to the alternative tax). The AMT preference is 28 percent of the excluded gain on stock acquired after December 31, 2011, and 42 percent on stock acquired before 2001.

To qualify as a small business, the corporation may not have gross assets of $50 million or more at issuance and may not be an S corporation. The business must also meet certain active trade or business requirements. As a result, small businesses in the service, hospitality, farming, finance, insurance, and mineral extraction sectors generally do not qualify for special treatment.

Under current law, the exclusion for stock acquired after 2011 is 50 percent (60 percent for certain businesses in empowerment zones), and the maximum effective capital gains tax rate on qualifying small business stock is 14 percent (11.2 percent in empowerment zones). In addition, 28 percent of the excluded gain will be an AMT preference item.

The president’s budget proposes to permanently exempt capital gains on qualifying small business stock acquired after December 31, 2012—thus reducing the effective tax rate to zero—and to eliminate the AMT preference for the excluded portion of the gain, regardless of when the stock was acquired.

The proposal would encourage more investment in some small businesses that qualify, but could also divert capital from more productive investments in firms that do not qualify for the benefit. By eliminating the second layer of tax, it would also encourage more qualifying firms to incorporate as C-corporations. Because of holding requirements, the proposal would cost nothing through 2016 but would then reduce revenues by $8 billion through 2022. The costs would rise in future years as more investments would qualify for the exemption from tax.

Additional Resources

Tax Policy Briefing Book: Capital Gains and Dividends: How are capital gains taxed?
The Complexity of Capital Gain Taxation, Tax Vox, February 24, 2009.

Double the Amount of Expensed Start-Up Expenditures.

Most costs incurred in starting a new business prior to the time it begins operating that would be deductible if the business was in operation are considered “start-up expenditures”. Generally, start-up expenditures are capitalized and not deductible except as a loss when the business is sold. However, a taxpayer may elect to deduct up to $5,000 of start-up expenditures in the taxable year the business begins operations and the remainder over a 180-month period that begins in the same month as operations. The initial $5,000 deduction is phased out dollar-for-dollar by the amount start-up expenditures exceed $50,000. The Creating Small Business Jobs Act of 2010 increased the initial deduction limit to $10,000 and the phase-out threshold to $60,000 for new businesses beginning operations in 2010.

The president’s budget proposes a permanent doubling of the initial deduction limit to $10,000 and increase in the phase-out threshold to $60,000 for taxable years ending on or after the date of enactment. The administration estimates that the provision would reduce revenues by $3.1 billion through 2022.

The Administration believes that this proposal would provide a stimulus to business formation and job creation.

Expand and Simplify the Tax Credit Provided to Qualified Small Employers for Non-Elective Contributions to Employee Health Insurance

A new tax credit for contributions by small employers to employees’ health insurance premiums was included in the Patient Protection and Affordable Care Act (PPACA). The credit is refundable for tax-exempt small employers. In 2010-2013, the credit rate is 35 percent (25 percent for tax-exempts) and available for any health insurance purchased from an insurance company licensed under state law. Beginning in 2014 the credit rate is 50 percent (35 percent for tax-exempts) and available only for health insurance purchased through an Affordable Insurance Exchange, and only for the year the small employer first offers health insurance to its employees and the two following years. To qualify for the credit, the small employer’s contribution must be uniform for all employees and be at least 50 percent of the premium, and the contribution amount is limited to the contribution rate times the average premium in the state. The credit is only available to employers with 25 or fewer full-time equivalent (FTE) employees during the taxable year, and is phased out for employers with between 10 and 25 FTE employees. In addition, the average FTE wage of employees must be no more than $50,000 and is phased out for average FTE wages between $25,000 and $50,000 (all wage amounts are indexed for inflation beginning in 2014). The phaseouts based on number of FTE employees and average FTE wage are additive.

The president’s budget proposes to expand eligibility for the credit to employers with 50 or fewer FTE employees, to increase the phaseout for employers with between 20 and 50 FTE employees, and to coordinate the phaseouts for the number of FTE employees and the average FTE wage. In addition, the proposal would eliminate the requirement for uniform contributions and the limitation based on the average premium in the state. The administration estimates that through 2022 the provision would reduce revenues by $13.2 billion and increase outlays by $1.0 billion, for a total cost of $14.2 billion.

The administration believes that the proposed changes would increase utilization of the credit and participation in Exchanges, broadening risk pools, and simplify the credit.