New levies: How the new Tax Act, just approved by Congress, affects early-stage company shareholders
In the dawn of 2013, Congress passed the American Taxpayer Relief Act of 2012, which addressed some of the tax issues that gave rise to one of the most popular phrases in 2012, the "fiscal cliff." The purpose of this article is not to cover all the provisions of the Tax Act, but rather to highlight some of the provisions that affect early-stage company shareholders. All tax rates referenced are for federal purposes and do not consider any state tax implications.
First, the basics. For individuals with taxable income above $400,000 and married couples above $450,000, tax rates on long-term capital gains increased from 15% to 23.8% (a combination of new long-term capital gain rate of 20% and 3.8% Medicare tax on net investment income). And the top marginal tax rate on ordinary income increased from 35% to 39.6%.
Other than an increase in the exemption amounts, there were no substantive changes to the Alternative Minimum Tax system. The federal AMT rate on ordinary income remains at 28% while the long-term capital gains rates mentioned above are the same for AMT purposes.
The 100% gain exclusion (up to a maximum $10 million of gain) for Qualified Small Business Stock was retroactively extended to apply to such stock acquired after Sept. 27, 2010, and before Jan. 1, 2014. A startup company would likely qualify as a QSBS if it is formed as a C corporation and the owners acquire their shares early in the life of the company. In addition, owners must hold their shares for at least five years to qualify for the exclusion.
If the shareholder had an exit event in 2012, some of the sales proceeds may be received after 2012, either in the form of an earnout or an escrow arrangement. If that's the case, the taxpayer will want to consider accelerating into the 2012 tax year the taxation of gain to be received after 2012.
Under the installment method, shareholders are taxed only on the gain related to the proceeds received in the year of sale. For amounts received after the year of sale, shareholders pay the taxes according to the rates in effect for the subsequent year or years. An individual, however...
The Deal Pipeline
January 28, 2013
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