The recent tax deal between the White House and Congress extended the exclusion of capital gains on investments made in small businesses through 2011.

As mentioned previously in this blog, the Small Business Jobs Act of 2010 increased the Section 1202 gain exclusion to 100% for individual taxpayers when they sell qualifying stock in a small business that was purchased after September 27, 2010 but before January 1, 2011. The new act recently signed by President Obama extends this capital gains exclusion to include investments made throughout 2011.

Each taxpayer is eligible to exclude up to the greater of $10 million or 10 times the taxpayer's basis in the stock. If the qualified stock was acquired by a partnership, the exclusion is usually determined at the partner level.

In general, to qualify, the stock purchased must have been issued by a C corporation with gross assets not exceeding $50 million immediately after the issuance.  The stock must also have been held by the buyer for at least five years before it can qualify for the exclusion. Take note that certain service and finance businesses are excluded from the definition of a qualified small business.

While the M&A markets and overall transaction activity is not directly affected by tax policy, the extension of the 100% Section 1202 gain exclusion will likely make it more attractive for buyers of lower middle market companies throughout 2011. While the extension provides an opportunity for tax efficient investing, keep in mind that there are a number of criteria you have to meet to qualify, so it is important that you get advice from a qualified tax professional before making an investment.