Taxes and Small Business Investments

Adam Krause
by Adam Krause, Contributor

Making an investment in a small business is a great way to encourage entrepreneurship and stimulate an important sector of the economy. It can also give you a break on your taxes.

If a small business has assets of less than $50 million, and is engaged in an active trade or business, it will likely meet the IRS standards to be classified as a Qualified Small Business (or QSB). Individuals who make investments in a QSB can deduct up to 50% of those capital gains from their taxes. To be eligible, you must have had the small business stock for at least 5 years, and the capital gains must be generated by selling that stock at a profit.

If you buy small business stock that was issued between February 17, 2009 and January 1, 2011, you may be able to exclude up to 75% of your capital gains on the investment, thanks to the American Recovery and Reinvestment Act (ARRA.)

You may defer paying taxes on capital gains if you use them to make investments in additional QSB stock within 60 days ― a tactic known as “rollover.” Keep in mind that if the profit you make from selling your QSB stock exceeds the cost of the new stock, you will still have to pay taxes on those gains.

Small business owners who have made personal investments in their business can save on their taxes by deducting available write-offs (such as start-up costs, insurance, and travel expenses). They can also use bills associated with the cost of business to offset profits, decreasing their total tax liability. Additionally, small business owners may consider hiring independent contractors, for whom they do not pay taxes, rather than full-time employees.

If you end up losing money on your small business investment, you may label your losses as “ordinary losses” rather than capital losses, and deduct them from your income for that tax year. For married couples filing joint tax returns, the maximum amount they can claim for a deduction is $100,000. If your filing status is “single,” the maximum amount you may deduct is $50,000.

The House of Representatives recently introduced a bill to eliminate capital gains taxes entirely on small business investments. If you are a small business owner as well as an investor, this bill would allow you to utilize a package of small business tax credits to counteract your alternative minimum tax (AMT). You would also be able to deduct the cost of health insurance for yourself and your family from your taxes. This bill is currently scheduled for debate on the Senate floor.