[Federal Register Volume 61, Number 110 (Thursday, June 6, 1996)]
[Proposed Rules]
[Pages 28821-28823]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-14231]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[IA-26-94]
RIN 1545-AU34


Qualified Small Business Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
50-percent exclusion for gain from certain small business stock. The 
proposed regulations reflect changes to the law made by the Omnibus 
Budget Reconciliation Act of 1993 (OBRA '93) and provide guidance to 
the issuers and owners of the stock of certain small businesses. This 
document also provides a notice of public hearing on these proposed 
regulations.

DATES: Written comments and outlines of oral comments to be presented 
at the public hearing scheduled for October 3, 1996 must be received by 
September 4, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (IA-26-94), Room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (IA-26-94), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., 
Washington, DC. The public hearing will be held in Room 2615, Internal 
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Catherine A. Prohofsky at (202) 622-4930; concerning submissions and 
the public hearing, Christina Vasquez at (202) 622-7180; (not toll-free 
numbers).

[[Page 28822]]

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) relating to section 1202 of the Internal 
Revenue Code. Section 1202 was added by section 13113 of OBRA '93. 
Section 1202 allows a taxpayer (other than a corporation) to exclude 50 
percent of certain gain from the sale of qualified small business stock 
held for more than 5 years.
    Section 1202(c)(1) provides that only stock acquired after August 
10, 1993, at its original issuance in exchange for money, property 
other than stock, or as compensation for services to the corporation 
(other than as an underwriter) qualifies for the exclusion (the 
original issue requirement). Section 1202(c)(3) provides two rules to 
prevent evasion of the original issue requirement. Under the first 
rule, the exclusion does not apply to stock acquired by the taxpayer 
if, at any time during the 4-year period beginning 2 years before the 
issuance of such stock, the corporation purchased (directly or 
indirectly) any of its stock from the taxpayer or a related person. 
Section 1202(c)(3)(A). Under the second rule, the exclusion does not 
apply to stock issued by a corporation if, during the 2-year period 
beginning 1 year before the issuance of such stock, the corporation 
made one or more purchases of its stock with an aggregate value (as of 
the time of the respective purchases) exceeding 5 percent of the 
aggregate value of all of its stock as of the beginning of the 2-year 
period. Section 1202(c)(3)(B).
    The IRS and Treasury are concerned that, in many cases, redemptions 
that have neither the purpose nor the effect of evading the original 
issue requirement may result in disqualification under these rules. 
Section 1202(k) authorizes Treasury to prescribe such regulations as 
may be appropriate to carry out the purposes of section 1202.

Explanation of Provisions

    The proposed regulations permit a corporation to redeem de minimis 
amounts of stock without violating the anti-evasion rules. The proposed 
regulations also provide that certain redemptions that are incident to 
events affecting a shareholder and are unlikely to result in evasion of 
the original issue requirement are disregarded in determining whether 
redemptions exceed the de minimis amounts. In particular, redemptions 
upon termination of a shareholder's employment or the death, 
disability, or mental incompetency of a shareholder are disregarded. 
Finally, the regulations clarify that transfers of stock by a 
shareholder to an employee in connection with the performance of 
services are not treated as redemptions for purposes of the anti-
evasion rules.
    The regulations will apply to stock issued after the date they are 
published as final regulations. The regulations will also apply to 
stock issued on or before that date, but only with respect to the 
effect of redemptions occurring after that date.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these proposed regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small businesses.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and 8 copies) that are submitted timely to the IRS. All comments will 
be available for public inspection and copying.
    The IRS and Treasury invite comments on matters addressed in the 
proposed regulations and suggestions for any additional exceptions and 
clarifications that may be appropriate in the context of the purpose of 
section 1202(c)(3) and the regulatory authority granted in section 
1202(k). The IRS and Treasury specifically invite comments from the 
small business community.
    The IRS and Treasury are particularly interested in comments 
regarding the scope of the exception for redemptions incident to 
termination of employment. The IRS and Treasury are committed to 
extending the exception to independent contractors, but seek comments 
regarding how to determine when a termination of the independent 
contractor's services has occurred.
    A public hearing has been scheduled for October 3, 1996, at 10 a.m. 
in Room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington, DC. Because of access restrictions, visitors will not be 
admitted beyond the building lobby more than 15 minutes before the 
hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments and an outline of topics to be discussed and 
the time to be devoted to each topic (signed original and 8 copies) by 
September 4, 1996.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Catherine A. 
Prohofsky, Office of Assistant Chief Counsel (Income Tax and 
Accounting). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1202-2 is also issued under 26 U.S.C. 1202(k).
    * * *
    Par. 2. Sections 1.1202-0 and 1.1202-2 are added to read as 
follows:


Sec. 1.1202-0  Table of contents.

    This section lists the major captions that appear in the 
regulations under Sec. 1.1202-2.

Sec. 1.1202-2  Qualified Small Business Stock; Effect of 
Redemptions.

    (a) Redemptions from taxpayer or related person.
    (1) In general.
    (2) De minimis amount.
    (b) Significant redemptions.
    (1) De minimis amount.
    (2) Special rule.
    (c) Transfers by shareholders in connection with the performance 
of services not treated as purchases.
    (d) Exceptions for termination of services, death, or disability 
or mental incompetency.
    (1) Termination of services.
    (2) Death.
    (3) Disability or mental incompetency.
    (e) Effective date.

[[Page 28823]]

Sec. 1.1202-2  Qualified small business stock; effect of redemptions.

    (a) Redemptions from taxpayer or related person--(1) In general. 
Stock acquired by a taxpayer is not qualified small business stock if, 
in one or more purchases during the 4-year period beginning on the date 
2 years before the issuance of the stock, the issuing corporation 
purchases (directly or indirectly) more than a de minimis amount of its 
stock from the taxpayer or from a person related (within the meaning of 
section 267(b) or 707(b)) to the taxpayer.
    (2) De minimis amount. For purposes of this paragraph (a), stock 
exceeds a de minimis amount only if the aggregate amount paid for the 
stock exceeds $10,000 and more than 2 percent of the stock held by the 
taxpayer and related persons is acquired. The following rules apply for 
purposes of determining whether the 2-percent limit is exceeded. The 
percentage of stock acquired in any single purchase is determined by 
dividing the stock's value (as of the time of purchase) by the value 
(as of the time of purchase) of all stock held (directly or indirectly) 
by the taxpayer and related persons immediately before the purchase. 
The percentage of stock acquired in multiple purchases is the sum of 
the percentages determined for each separate purchase.
    (b) Significant redemptions--(1) In general. Stock is not qualified 
small business stock if, in one or more purchases during the 2-year 
period beginning on the date 1 year before the issuance of the stock, 
the issuing corporation purchases more than a de minimis amount of its 
stock and the purchased stock has an aggregate value (as of the time of 
the respective purchases) exceeding 5 percent of the aggregate value of 
all of the issuing corporation's stock as of the beginning of such 2-
year period.
    (2) De minimis amount. For purposes of this paragraph (b), stock 
exceeds a de minimis amount only if the aggregate amount paid for the 
stock exceeds $10,000 and more than 2 percent of all outstanding stock 
is purchased. The following rules apply for purposes of determining 
whether the 2-percent limit is exceeded. The percentage of the stock 
acquired in any single purchase is determined by dividing the stock's 
value (as of the time of purchase) by the value (as of the time of 
purchase) of all stock outstanding immediately before the purchase. The 
percentage of stock acquired in multiple purchases is the sum of the 
percentages determined for each separate purchase.
    (c) Transfers by shareholders in connection with the performance of 
services not treated as purchases. A transfer of stock by a shareholder 
to an employee or independent contractor (or to a beneficiary of an 
employee or independent contractor) is not treated as a purchase of the 
stock by the issuing corporation for purposes of this section even if 
the stock is treated as having first been transferred to the 
corporation under Sec. 1.83-6(d)(1) (relating to transfers by 
shareholders to employees or independent contractors).
    (d) Exceptions for termination of services, death, or disability or 
mental incompetency. A stock purchase is disregarded for purposes of 
this section if--
    (1) Termination of services--(i) Employees and directors. The stock 
was acquired by the seller in connection with the performance of 
services as an employee or director and the stock is purchased from the 
seller incident to the seller's retirement or other bona fide 
termination of such services;
    (ii) Independent contractors. [Reserved];
    (2) Death. The stock is purchased from the deceased shareholder's 
estate, beneficiary, heir, surviving joint tenant, or from a surviving 
spouse or a trust established by a decedent, the stock is purchased 
within 3 years and 9 months from the date of death, and the stock (or 
an option to acquire the stock) was acquired by the seller before or on 
account of the death of the decedent; or
    (3) Disability or mental incompetency. The stock is purchased 
incident to the disability or mental incompetency of the selling 
shareholder.
    (e) Effective date. This section applies to stock issued after the 
date these regulations are published as final regulations in the 
Federal Register. This section also applies to stock issued on or 
before the date these regulations are published as final regulations in 
the Federal Register, but only with respect to the effect of purchases 
by the issuing corporation that occur after that date.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-14231 Filed 6-3-96; 11:29 am]
BILLING CODE 4830-01-U