Equity investment in small business tax credit

(a)

In general

Subpart D of part IV of subchapter A of chapter 1 (relating to business related credits) is amended by adding at the end the following new section:

45N.

Equity investment in small business tax credit

(a)

General rule

For purposes of section 38, in the case of a qualified investor, the equity investment in small business tax credit determined under this section for the taxable year is an amount equal to 25 percent of the amount of each qualified equity investment made by the qualified investor during the taxable year. (b)

Credit amount

For purposes of determining the small business tax credit under subsection (a)— (1)

Limitation per qualified investor

The amount of qualified equity investments made by the qualified investor during the taxable year shall not exceed $500,000. (2)

Limitation per qualified small business

The amount of qualified equity investments made by the qualified investor in a qualified small business during the taxable year shall not exceed $250,000. (c)

Definitions

For purposes of this section— (1)

Qualified investor

The term qualified investor means— (A)an individual who qualifies as an accredited investor under rules and regulations prescribed by the Commissioner of the Securities and Exchange Commission, or (B)a partnership with respect to which all of the partners are individuals who qualify as accredited investors under rules and regulations prescribed by the Commissioner of the Securities and Exchange Commission. (2)

Qualified equity investment

The term qualified equity investment means the transfer of cash or cash equivalents in exchange for stock or capital interest in a qualified small business. (3)

Qualified small business

The term qualified small business means a private small business concern (within the meaning of section 3 of the Small Business Act)— (A)that meets the applicable size standard (as in effect on January 1, 2005) established by the Administrator of the Small Business Administration pursuant to subsection (a)(2) of such section, and (B)has its principal place of business in the United States.

For purposes of this section, all members of the same controlled group of corporations (within the meaning of section 267(f)) and all persons under common control (within the meaning of section 52(b)) shall be treated as 1 qualified small business.

(d)

Active business requirement

(1)

In general

Holding stock in a qualified small business shall not be treated as a qualified equity investment unless, during substantially all of the qualified investor’s holding period for such stock, such qualified small business meets the active business requirements of paragraph (2). (2)

Requirements

(A)

In general

For purposes of paragraph (1), the requirements of this paragraph are met by a qualified small business for any period if during such period at least 80 percent (by value) of the assets of such qualified small business are used by such qualified small business in the active conduct of 1 or more qualified trades or businesses. (B)

Special rule for certain activities

For purposes of subparagraph (A), if, in connection with any future qualified trade or business, a qualified small business is engaged in— (i)start-up activities described in section 195(c)(1)(A), (ii)activities resulting in the payment or incurring of expenditures which may be treated as research and experimental expenditures under section 174, or (iii)activities with respect to in-house research expenses described in section 41(b)(4),

assets used in such activities shall be treated as used in the active conduct of a qualified trade or business. Any determination under this subparagraph shall be made without regard to whether a qualified small business has any gross income from such activities at the time of the determination.

(C)

Qualified trade or business

For purposes of this paragraph, the term qualified trade or business is as defined in section 1202(e)(3). (D)

Stock in other entities

(i)

Look-thru in case of subsidiaries

For purposes of this subsection, stock and debt in any subsidiary entity shall be disregarded and the parent qualified small business shall be deemed to own its ratable share of the subsidiary’s assets, and to conduct its ratable share of the subsidiary’s activities. (ii)

Portfolio stock or securities

A qualified small business shall be treated as failing to meet the requirements of subparagraph (A) for any period during which more than 10 percent of the value of its assets (in excess of liabilities) consists of stock or securities in other entities which are not subsidiaries of such qualified small business other than assets described in subparagraph (E)). (iii)

Subsidiary

For purposes of this subparagraph, an entity shall be considered a subsidiary if the parent owns more than 50 percent of the combined voting power of all classes of stock entitled to vote, or more than 50 percent in value of all outstanding stock, of such entity. (E)

Working capital

For purposes of subparagraph (A), any assets which— (i)are held as a part of the reasonably required working capital needs of a qualified trade or business of the qualified small business, or (ii)are held for investment and are reasonably expected to be used within 2 years to finance research and experimentation in a qualified trade or business or increases in working capital needs of a qualified trade or business,

shall be treated as used in the active conduct of a qualified trade or business. For periods after the qualified small business has been in existence for at least 2 years, in no event may more than 50 percent of the assets of the qualified small business qualify as used in the active conduct of a qualified trade or business by reason of this subparagraph.

(F)

Maximum real estate holdings

A qualified small business shall not be treated as meeting the requirements of subparagraph (A) for any period during which more than 10 percent of the total value of its assets consists of real property which is not used in the active conduct of a qualified trade or business. For purposes of the preceding sentence, the ownership of, dealing in, or renting of real property shall not be treated as the active conduct of a qualified trade or business. (G)

Computer software royalties

For purposes of subparagraph (A), rights to computer software which produces active business computer software royalties (within the meaning of section 543(d)(1)) shall be treated as an asset used in the active conduct of a trade or business. (e)

Certain purchases by qualified investor of its own stock

(1)

Redemptions from qualified investor or related person

Stock acquired by the qualified investor shall not be treated as a qualified equity investment if, at any time during the 4-year period beginning on the date 2 years before the issuance of such stock, the qualified small business issuing such stock purchased (directly or indirectly) any of its stock from the qualified investor or from a person related (within the meaning of section 267(b) or 707(b)) to the qualified investor. (2)

Significant redemptions

Stock issued by a qualified small business to a qualified investor shall not be treated as a qualified equity investment if, during the 2-year period beginning on the date 1 year before the issuance of such stock, such qualified small business made 1 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 such 2-year period. (3)

Treatment of certain transactions

If any transaction is treated under section 304(a) as a distribution in redemption of the stock of any qualified small business, for purposes of subparagraphs (A) and (B), such qualified small business shall be treated as purchasing an amount of its stock equal to the amount treated as such a distribution under section 304(a). (f)

Special rule for related parties

(1)

In general

No credit shall be allowed under subsection (a) with respect to a qualified equity investment made by a qualified investor in a qualified small business that is a related party to the qualified investor. (2)

Related party

For purposes of paragraph (1), a person is a related party with respect to another person if such person bears a relationship to such other person described in section 267(b) or 707(b), or if such persons are engaged in trades or businesses under common control (within the meaning of subsections (a) and (b) of section 52). (g)

Recapture of credit in certain cases

(1)

In general

If, at any time during the 3-year period beginning on the date that the qualified equity investment is made by the qualified investor, there is a recapture event with respect to such investment, then the tax imposed by this chapter for the taxable year in which such event occurs shall be increased by the credit recapture amount. (2)

Credit recapture amount

For purposes of paragraph (1), the credit recapture amount is an amount equal to the sum of— (A)the aggregate decrease in the credits allowed to the taxpayer under section 38 for all prior taxable years which would have resulted if no credit had been determined under this section with respect to such investment, plus (B)interest at the underpayment rate established under section 6621 on the amount determined under subparagraph (A) for each prior taxable year for the period beginning on the due date for filing the return for the prior taxable year involved.

No deduction shall be allowed under this chapter for interest described in subparagraph (B).

(3)

Recapture event

For purposes of paragraph (1), there is a recapture event with respect to a qualified equity investment if such investment is sold, transferred, or exchanged by the qualified investor, but only to the extent that such sale, transfer, or exchange is not the direct result of a complete or partial liquidation of the qualified small business in which such qualified equity investment is made. (4)

Special rules

(A)

Tax benefit rule

The tax for the taxable year shall be increased under paragraph (1) only with respect to credits allowed by reason of this section which were used to reduce tax liability. In the case of credits not so used to reduce tax liability, the carryforwards and carrybacks under section 39 shall be appropriately adjusted. (B)

No credits against tax

Any increase in tax under this subsection shall not be treated as a tax imposed by this chapter for purposes of determining the amount of any credit under this chapter or for purposes of section 55. (h)

Basis reduction

The basis of any qualified equity investment shall be reduced by the amount of any credit determined under this section with respect to such investment. (i)

Regulations

(1)

In general

The Secretary shall prescribe such regulations as necessary to carry out the provisions of this section. (2)

Certification of qualified equity investment

Such regulations shall require that a qualified investor— (A)certify that the small business in which the equity investment is made meets the requirements described in subsection (c)(3), and (B)include the name, address, and taxpayer identification number of such small business on the return claiming the credit under subsection (a). (j)

Termination

This section shall not apply to qualified equity investments made in taxable years beginning after December 31, 2011.

(b)

Credit made part of general business credit

Subsection (b) of section 38 is amended by striking and at the end of paragraph (25), by striking the period at the end of paragraph (26) and inserting , and, and by adding at the end the following new paragraph:

(27)in the case of a taxpayer, the equity investment in small business tax credit determined under section 45N(a).

(c)

Clerical amendment

The table of sections for subpart D of part IV of subchapter A of chapter 1 of such Code is amended by adding at the end the following new item:

Sec. 45N. Equity investment in small business tax credit.

(d)

Effective date

The amendments made by this section shall apply to qualified equity investments made after December 31, 2006, in taxable years beginning after such date.