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PATH Act: What It Means For Investors

Post on: April 15, 2016 | Bret Daniel | 0


Raising private capital should not be complicated. That’s what we believe at WealthForge and that sentiment is gaining traction as a broader principle necessary for a dynamic, thriving economy. And one way to put money back into private companies is the permanent 100% exclusion of gains realized on Qualified Small Business Stock (QSBS).

The PATH Act and Section 1202
On December 18, 2015, Congress passed the Protecting Americans from Tax Hikes Act (PATH Act). Part of the act is a small provision that packs a big punch for investors, entrepreneurs, and founders of early stage companies: an increase and permanent extension of a capital gains exclusion for QSBS.

The QSBS exclusion, codified in Section 1202, has been around since 1993, but the amount of the exclusion has bounced between 50% and 100% for the last 23 years. The PATH Act increases the exclusion back to 100%—permanently—and applies it retroactively to QSBS purchased in 2015. QSBS shareholders can exclude the greater of ten times the original investment or $10 million. Standing alone, the exclusion itself will save shareholders millions of dollars. Coupled with the ability to rollover gains to reinvest in other qualifying start-ups, savings could be even more dramatic. Moreover, the excluded gain is no longer subject to the Alternative Minimum Tax, further enhancing the value of the exclusion for taxpayers.

What does this mean for you? The possibilities, while not endless, are certainly many. A qualifying early stage company could be an opportunity to realize a tax-free gain of up to $10 million or more depending on the size of your investment. Now that the PATH Act has made the exclusion permanent, QSBS shareholders can count on a greater degree of predictability and security in their investments.

What Qualifies as QSBS?
The opportunity is too good to ignore and is well worth the time to determine whether your investment, or your business, may qualify for the exclusion. The ground rules are as follows:

  • The exclusion applies to domestic C-corporations with less than $50 million in assets at the time of or immediately after original issue.
  • The taxpayer must have acquired the stock at original issue and held it for at least five years.
  • For substantially all of the holding period, the business must use at least 80% of its assets in the active conduct of at least one Qualified Trade or Business (“Active Business Requirement”).

Qualified Trade or Business is defined in Section 1202(e)(3) by exclusionary terms, but the IRS has interpreted the section broadly, noting that “the thrust of Section 1202(e)(3) is that businesses are not qualified trades or businesses if they offer value to customers primarily in the form of services...or in the form of individual expertise.”1 By way of example, restaurants, hotels, law firms, and financial asset management firms would not qualify. On the other hand, businesses that deploy “manufacturing assets [or] intellectual property assets to create value for customers” would qualify.2

The WealthForge Network
At WealthForge, we want to see capital flowing freely across the board. Part of that vision is helping companies and investors connect, identify opportunities, and maximize the potential of each and every dollar. That’s why we’ve created The WealthForge Network, a network of broker-dealers and Registered Investment Advisors (RIAs) designed to help facilitate the free and efficient flow of capital to growing companies. Tax incentives such as the QSBS exclusion present tremendous opportunity, and The WealthForge Network is here to help businesses and investors capitalize.


1IRS Private Letter Ruling 201436001, 2014 WL 4383322.

Disclaimer: WealthForge provides this information to our clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.

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About author

Bret Daniel

Bret is part of the legal team at WealthForge where he manages client contract flow, internal policy development, and contributes thought leadership on issues ranging from tax to employment law. Bret brings a small business background to WealthForge and is currently a law student at the University of Richmond.

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