On September 13, 2021, Democrats on the House Ways and Means Committee released proposed tax legislative text as part of a broader $3.5 trillion budget proposal. Among the proposals is a substantial limitation of the qualified small business stock (QSBS) gain exclusion for certain taxpayers that, if enacted as proposed, would be effective beginning September 13, 2021.
Background on QSBS
Section 1202(a) of the Code1 allows non-corporate taxpayers to exclude from gross income a percentage of capital gain recognized on the sale of QSBS that is held for more than five years.2 QSBS issued on or after September 28, 2010, is eligible for 100 percent exclusion from U.S. federal capital gains tax,3 up to a specified cap, while QSBS issued between February 18, 2009, and September 27, 2010, is eligible for 75 percent exclusion and QSBS issued on or after August 11, 1993, and prior to February 18, 2009, is eligible for 50 percent exclusion. The 50 percent and 75 percent gain exclusions are based on a 28 percent capital gains rate. Entrepreneurs and investors who have formed or made investments in corporations that are qualified small businesses as defined in Section 1202(d) of the Code often take advantage of this exclusion.
Proposed Limitation of QSBS Gain Exclusion Effective September 13, 2021
House Democrats proposed to amend Section 1202(a) of the Code to eliminate the 75 percent and 100 percent gain exclusions for certain taxpayers. Specifically, the 75 percent and 100 percent gain exclusions would no longer be available to any taxpayer (i) whose adjusted gross income (AGI) equals or exceeds $400,000 or (ii) that is a trust or estate. Such taxpayers would still be eligible for the 50 percent QSBS gain exclusion that existed prior to February 18, 2009. The effect of this proposed legislation is to repeal Obama-era QSBS benefits for taxpayers with an AGI of $400,000 or more or that are trusts and estates.
The proposed legislation is effective for sales and exchanges of QSBS that occur on or after September 13, 2021. However, any sale or exchange of QSBS made pursuant to written binding contract in effect on September 12, 2021, that is not modified in any material respect thereafter would not be subject to the proposed limitations.
Other Tax Proposals
A few other notable individual and corporate tax rate changes in the House Democrats' proposal include:
|Proposal||Code Section||Effective Date|
|Elimination of QSBS gain exclusion for certain high-income taxpayers (see pages 628-629)||1202(a)||September 13, 2021|
|Raising the maximum corporate tax rate to 26.5% from 21% (see pages 525-528)||11(b)||January 1, 2022|
|Raising the top marginal individual income tax rate to 39.6% from 37% (see pages 636-641)||1(j)||January 1, 2022|
|Raising the capital gains rate for certain high-income individuals to 25% from 20% (see pages 641-646)||1(h)||Taxable years ending after September 13, 2021 (subject to binding contract exception)|
|Institution of a new 3% surcharge on certain high-income individuals, estates, and trusts by adding a new Section 1A to the Code (see pages 652-654)||1A||January 1, 2022|
|Extension of renewable energy credits through 2033 (see pages 111-125)||45(d)||January 1, 2022|
The Wilson Sonsini tax team is closely monitoring legislative activity and analyzing the effects of congressional tax proposals. If you have any questions about QSBS or other legislative developments, please contact Greg Broome, Myra Sutanto Shen, or any other attorney in the firm's tax practice.
Trent McKenzie contributed to the preparation of this alert.