Debate: Should the Tax Break on Small-Business Stock Be Scaled Back?

Two professors discuss cutting the capital gains tax exclusion from 100% to 50% for high-income taxpayers.

Under current law, taxpayers can exclude gain on the sale of certain qualified small-business stock (QSBS) if the taxpayer holds the stock for at least five years prior to sale. If the stock was purchased after Sept. 27, 2010, 100% of the gain on the sale of QSBS can be excluded (a 50% or 75% exclusion applies if the stock was purchased in earlier years).

Pending legislation has been proposed that would reduce the exclusion from 100% to 50% for taxpayers with adjusted gross income that exceeds $400,000 if the stock was purchased after Feb. 18, 2009 (the date the previously applicable 75% exclusion became effective).

We asked two professors and authors of ALM’s Tax Facts with opposing political viewpoints to share their opinions about limiting the gain exclusion for qualified small-business stock. 

Below is a summary of the debate that ensued between the two professors.

Their Votes:

Bloink

Byrnes

Their Reasons:

Bloink: This new proposed limitation would apply only to high-income taxpayers who have the means to manipulate their income to avoid paying taxes. Currently, the QSBS exclusion provides yet another tax loophole to allow the wealthiest Americans to avoid paying their fair share of taxes. We need to be focused on eliminating as many of these loopholes as possible — especially if we’re going to forgo raising income tax rates on those high-income taxpayers. 

Byrnes: The QSBS exclusion really has less to do with providing a tax benefit to investors and more to do with giving a helping hand to small-business owners seeking to raise capital, especially in a challenging market. The 100% exclusion is a powerful motivator for investors to support our small-business owners. Limiting the exclusion to 50% not only adds complexity to the tax code, but also hurts the small-business owners we should be trying to protect. 

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Bloink: I wouldn’t be against eliminating the exclusion for the wealthiest Americans entirely, but this proposal is a good compromise that limits the exclusion to 50% of the taxpayer’s gain. That’s a good solution to continue encouraging Americans to invest in small businesses while also eliminating a loophole that primarily benefits the wealthy.

Byrnes: This is one of those proposals that are set to be retroactive to the date of the original proposal, not prospective from the date the law is signed. This new system is unfair to the taxpayer with a $401,000-plus gross income who relied in good faith on the 100% exclusion when making the investment or sale.

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Bloink: The QSBS exclusion primarily benefits the wealthy, true. But it can also provide a powerful tax benefit to lower-income taxpayers who want to invest in small-business options. This provision would affect only the wealthiest Americans — who may very well have other incentives for investing in small businesses and our economy. We need to take steps to ensure that  the wealthiest Americans are paying their fair share, and they currently have too many loopholes to help them avoid paying any taxes at all.

Byrnes: This type of legislation makes it impossible for taxpayers to plan. In the end, it’s going to harm our small businesses because taxpayers can’t rely on the exclusion when making their planning moves. Investors today have options, and our current legislation is designed to help investors decide to support small businesses. Modifying today’s rule would significantly harm the very small-business owners that we should be trying to support in today’s challenging economy.

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