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A Guide to the Small Business Capital Gains Tax

 

Recently, there has been a movement to change the rules regarding the small business capital gains tax. It is proposed to exempt all capital gains for qualified small business's stock held for more than five years from taxation--instead of the current rate of 75 percent--in order to encourage angel investors and capital investors to invest in small businesses (and therefore improve the economy). The remaining 25 percent of gain is taxed at the maximum rate of 28 percent. Prior to the passage of the American Recovery and Reinvestment Act of February 2009, the exemption rate was 50 percent.

Not All Small Businesses Qualify

In order to qualify, a small business must not exceed gross assets of $50 million and must not be an S corporation. An S corporation does not pay any federal income tax. Instead, its income and losses are shared and passed through its shareholders, who have to report the income or loss on their own individual income tax returns.

Small Business Matters

The small business must not be engaged in an active trade or business in which the reputation or skill of one or more of its employees is the principal asset of that business. Businesses performing services pertaining to law, health, financial, engineering, banking, insurance, farming, manufacturing, restaurant or hotel are examples of businesses that do not qualify.

There is some speculation that this change in rate will not significantly improve the economy since there are not enough angel investors or capital investors interested in investing in qualified small businesses.

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