Summary of IRC Section 1202 Qualified Small Business Stock

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Under IRC Section 1202, noncorporate taxpayers generally may exclude 100% of their gain (subject to a per-issuer limitation) from the sale or exchange of qualified small business (“QSB”) stock if the QSB stock is acquired after September 27, 2010 and has been held for more than five years.

Qualified Small Business Eligibility

Stock of a corporation is QSB stock if the following requirements are met:

  • “C” Corporation. The stock must be issued by a domestic “C” corporation after August 10, 1993.
  • Original Issuance. The taxpayer must have acquired the QSB stock at original issue (including through an underwriter) in exchange for money or property other than stock or for services.
  • Gross Assets Test. The corporation’s gross assets must be $50 million or less both before and immediately after the stock is issued.
  • Stock can continue to be QSB stock if the corporation’s assets exceed $50 million after the issuance of the stock; however, once the $50 million threshold has been exceeded, the corporation will not be permitted to again issue stock that will qualify as QSB stock.
  • The determination of gross assets is generally determined by reference to the amount of cash and the adjusted tax basis of other property (fair market value in the case of contributed property).
  • Active Business Requirement. At least 80% of the corporation’s assets (based on value) must be used in the active conduct of one or more “qualified trades or businesses.”
  • Qualified trades or business are any trades or businesses other than specified business engaged in providing services (e.g., health, law and those relying on the reputation or skill of employees), finance, farming, certain natural resource production or extraction or a lodging or restaurant business.
  • Five-Year Holding Period. In order to qualify for the exclusion, the taxpayer must hold the QSB stock for more than five years.
  • Stock Owned by Partnership or S Corporation. Stock owned by a pass-through entity qualifies as QSB stock to an individual owner of the pass-through if:
    • The amount is attributable to gain on the sale or exchange by the pass-through entity of stock that is QSB stock in the hands of the pass-thru entity (determined by treating the pass-through entity as an individual);
    • The pass-through entity held the stock for more than five years; and
    • The amount is includible in the taxpayer’s gross income by reason of the holding of an interest in the pass-through entity that was held by the taxpayer on the date on which the pass-through entity acquired the stock and at all times thereafter before the disposition of the stock by the pass-through entity.
  • Redemption Rules. Certain redemptions of a taxpayer’s stock by the corporation can cause the taxpayer’s stock to not qualify as QSB stock. The rules are more restrictive if there is a “significant redemption” of more than 5% of the QSB’s stock (by value) during a specified period.
  • Per-Issuer Limitation. Taxpayers can only exclude a specified amount of gain with respect to the QSB stock of a single issuer. The gain limitation is the greater of:
    • Ten times the taxpayer’s aggregate adjusted tax basis in the QSB stock of that issuer disposed by the taxpayer during the taxable year, or
    • Ten million dollars (reduced by the aggregate amount of the gain taken into account by the taxpayer under Section 1202 with respect to that issuer in any prior year).

For example, a person acquired 1,000 shares of QSB stock on July 15, 2015, at a total cost of $100,000. They then sell all their shares in 2023 for $20 million, and the per-issuer limitation is the greater of: (1) $1 million, i.e., 10 times X’s $100,000 total basis in the 100 shares, or (2) $10 million. Since they acquired the QSB stock after Sept. 28, 2010, the 100 percent exclusion applies. On their 2023 return, they can exclude $10 million of the $20 million gain realized on the disposition. Any gain in excess of the $10 million limitation would be taxed as capital gain.

Contact your Varnum attorney with any questions.

Planning a Giveaway: Promotional Methods and Privacy Considerations

Once a company has decided to launch a giveaway to generate excitement and buzz around their brand, there are several legal considerations that must be thoroughly reviewed and complied with before proceeding. These typically include rules and regulations around eligibility, entry requirements and prize fulfillment, among others.

In addition to complying with legal requirements surrounding rules and eligibility, there are other crucial factors that companies must consider when launching a giveaway campaign. First and foremost, it is essential to choose the right format for the giveaway based on target audience, the company’s objectives and the desired outcome. Additionally, partnering with the right organizations can help maximize the reach and impact of the giveaway; however, careful consideration should be given to selecting reputable and trustworthy partners. Finally, companies must prioritize protecting customers’ privacy throughout the giveaway process and comply with data privacy laws, especially when collecting personal data.

Choosing the Right Format

There are many ways to run a promotional giveaway – from prizes to entry periods to advertising tools, there are endless possibilities when organizing a contest or sweepstakes. The format and platform a company chooses will depend on its budget, goals and target audience.

Today, many companies use social media to host giveaways to increase their followers, boost engagement and improve brand awareness. However, Instagram, Facebook, Twitter and TikTok all have different and unique rules for running a giveaway. Failure to follow each platform’s rules could lead to a company’s content being deleted or banned. In fact, certain social media websites have promotion guidelines including specific language which must be used in the post to inform the entrant that the website is not affiliated nor a sponsor of the giveaway. For example, Instagram requires that promotions include “[a] complete release of Instagram by each entrant or participant” and “[a]cknowledgement that the promotion is in no way sponsored, endorsed or administered by, or associated with, Instagram.”[1]

Similar considerations should be made when broadcasting prize promotions on the television and radio. Specifically, the Federal Communications Commission (the “FCC”), states that the material terms of the promotion should be disclosed via “periodic disclosures broadcast on the station” or “[w]ritten disclosure on the station’s Internet Web site, the licensee’s Web site, or if neither . . . has its own Web site, any Internet Web site that is publicly accessible.”[2]

Choosing a Third-Party Administrator

If a company is not running the giveaway independently, it will need to hire a third-party administrator. It is important to choose third parties that have good reputations and are familiar with the laws and regulations governing promotional giveaways. If a third-party administrator is involved in the giveaway, a company must clearly identify the third-party by name, be clear in the official rules about what entrant information the third-party may receive to conduct the giveaway and ensure the third-party will delete the entrant information as soon as possible at the conclusion of the giveaway. Failure to properly identify the third-party administrator’s role and how information is retained could lead to serious privacy and data security liability.

Protecting Customers’ Privacy

When a company runs a promotional giveaway, it may need to collect personal information from entrants, such as their name, email address and mailing address. Companies should protect this information from unauthorized access by using a secure website and  having a privacy policy in place.

Generally, companies should avoid storing personal information or sharing said information with third parties beyond that necessary to conduct the giveaway. Ultimately, the giveaway must comply with data privacy laws, and its official rules must adequately outline how information will be collected, used, retained and disposed.

Companies should not use the entrant information to create a giveaway/sweepstakes mailing list without requesting consent and providing a method to opt-out. For example, as noted in the CAN-SPAM Act, if an entrant is given the option to consent to future e-mails, all future messages must include a clear and conspicuous method to opt-out.[3] Likewise, pursuant to the DMPA, the promoter of a mailed giveaway “must establish and maintain a notification system that provides for any individual . . . to notify the system of the individual’s election to have the name and address of the individual excluded from all lists of names and addresses used by that promoter to mail any skill contest or sweepstakes.”[4]

Giveaways are an excellent vehicle to promote brand awareness and to engage with a company’s audience. If you have any questions or would like to review your giveaway rules to ensure compliance with state and federal laws, please contact your Varnum attorney.

*Please note, the information in this advisory should not be construed as an exhaustive list of everything that should be included in the official rules of a giveaway nor a list of all laws that should be reviewed and factors considered when drafting and promoting a giveaway.

[1] Promotion Guidelines | Instagram Help Center.

[2] 47 C.F.R. § 73.1216(b)

[3] 15 U.S.C. § 7704(a)(3)

[4] 39 U.S.C.A. § 3017(c)(2).

Remote Inspection of I-9 Documents to End July 31, 2023

Temporary U.S. Department of Homeland Security COVID-19 policy allowing for remote inspection of Form I-9 documents will end on July 31, 2023. Employers have until August 30, 2023 to complete physical inspection of any Form I-9 identity and employment eligibility documents. This is also an opportunity to conduct a Form I-9 self-audit to ensure compliance. Please contact your Varnum immigration attorney if you have any questions.

The End of the COVID Public Health Emergency and Its Effect on Employee Benefit Plans

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The COVID-19 public health emergency ends on May 11, 2023. The emergency resulted in two big changes to welfare plans: the relaxation of certain notification and timing requirements, and the requirement for plans to cover COVID testing and vaccination at no cost to plan participants. While the public health emergency ends May 11, 2023, plans have a grace period until July 11 to take certain actions and come into compliance with the normal rules.

Plan Sponsor Requirements

Before the grace period ends, plan sponsors will generally need to follow the rules that existed before COVID. Among the most important of these rules are the requirements for plan sponsors to:

  • Timely provide all notices, including those for HIPAA and COBRA.
  • Review COVID-related coverage under their employee assistance programs (EAPs) to determine if such coverage would be considered “significant medical care,” which can result in additional reporting and compliance obligations. 
  • Review telehealth options to ensure they are properly integrated and provided by an entity that can comply with the post-COVID requirements. Telehealth rules were substantially relaxed during COVID. With telehealth now expected and utilized by more participants, getting telehealth right is more crucial than before.

Plan Sponsor Decisions

With the end of the public health emergency, plan sponsors must also make several important decisions with respect to their employee benefit plans:
• Whether testing will continue free of charge or will be subject to cost sharing.
• Whether non-preventative care vaccines for COVID will continue to be free of charge.
• Whether costs for certain COVID-related services will continue to be posted.

As they are mostly based on what costs the plan sponsor or plan will cover going forward, these plan sponsor decisions are largely business-related. In the absence of a choice by the plan sponsor, the insurance provider will likely make a default choice. The important legal consideration is that the plan documents and employee communications should be consistent and accurately reflect the plan sponsor’s decisions.

Participant Requirements

In addition to the changes for plan sponsors, the end of the public health emergency will result in the reinstatement of a number of rules applicable to participants. Participants will need to:

• Follow the HIPAA Special Enrollment timing rules.
• Elect COBRA within the 60-day window for elections.
• Make all COBRA payments timely.
• Timely notify the plan of disabilities and qualifying events under COBRA.
• Follow the timing limitations of their plans and insurance policies regarding filing claims, appeals and external reviews.

Next Steps

First, plan sponsors should decide what COVID-related coverage will remain fully paid by the plan, if any. Some insurance companies are already starting to communicate with participants, and maintaining a consistent message will avoid unnecessary problems.

Second, plan sponsors should review their EAP and telehealth coverages for compliance with the rules that will soon be in effect. To the extent necessary, plan sponsors should update the documentation for their plans.

Finally, plan sponsors should consider a voluntary reminder communication to participants. Many rules have been relaxed over the last two years or so, and participants may be confused regarding the rules. A reminder may save stress for participants and those administering the plan, and will also serve to document the plan sponsor’s intention to properly follow the terms of the plan.

If you have questions, concerns, or want to discuss your circumstances, please contact a member of Varnum’s employee benefits team.

Preparing for Michigan Liquor License Renewal 2023-2024

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All liquor licenses issued by the State of Michigan Liquor Control Commission (MLCC), including all on premises, off premises, manufacturer, wholesaler and importer licenses, must be renewed by May 5, 2023. All liquor licenses issued by the MLCC are effective for periods of one year each and expire April 30 of each licensing year. Exceptions exist only for certain sales representative and vendor permits, which are valid for terms of three years. However, on May 1, 2023, the Michigan Liquor Control Commission extended the renewal period for liquor licenses until midnight on Friday, May 5, 2023.

For those with licenses currently in escrow, different rules for renewal apply, but these licenses must also be renewed, despite the non-active nature of the license. Finally, no exceptions to the renewal rules exist for recently issued licenses: liquor licenses issued in the 2022 – 2023 licensing year must be renewed on or prior to May 5 as well.

In order for restaurants, hotels, retail stores and other liquor licensed operators to retain their licensed status with the ability to furnish and/or sell alcoholic beverages, whether at retail or wholesale, each Michigan licensee must renew their existing licenses on or prior to the extended deadline. The failure of an active licensee to timely renew a license is a violation of the Michigan Liquor Control Code and will subject the license to termination.

Renewal Process Modifications

The MLCC has recently modified the renewal process by adding a credit card option for liquor license renewal payments. The online renewal portal now accepts payments using Visa, Mastercard, American Express and Discover. Payment by electronic funds transfers (EFT) from bank accounts continues to be an available option too. If there are multiple transactions, you need to allow five (5) minutes in between transactions of the same amount with the same account information. Otherwise, the system thinks it is a duplicate payment.

Licensees can now print their own renewal license online. If licensees have no changes to their renewal license application, they may print their own license for the May 5, 2023, renewal date. If a renewal application has been mailed to the MLCC prior to April 1, 2023, it may also be printed online. Licensees can only print active licenses for the current renewal year. Escrow renewals do not contain licensing documents that require printing. Instructions for printing renewal licenses can be found here.  

Typically, the administrative staff of the MLCC will mail renewal packages in the middle of March. The members of Varnum’s Hospitality and Beverage Control Law Practice Group are currently responding to several license inquiries and are handling the renewal of the licenses for a number of our clients when so requested. If you would like to obtain our assistance in this regard or have any other questions, please contact us. We would be happy to review and submit the appropriate documentation to the State of Michigan to assure that your license is properly renewed and delivered to you on a timely basis to avoid any suspensions of your license.

Varnum Attorneys Support Letter to FTC on Proposed Ban of Non-Compete Agreements

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On April 19, 2023, in response to the FTC’s request for comments, Varnum attorneys Ziyad Hermiz and Timothy Monsma joined several leading law firms across the country to sign a letter to the Federal Trade Commission (FTC) calling for a cautious approach to testing the potential impacts of the proposed ban on non-compete agreements.

The letter, which was submitted by more than 100 attorneys who advise on and litigate matters on behalf of employers involving trade secrets and restrictive covenants, raises concerns and practical considerations for businesses stemming from the FTC’s unprecedented attempt to limit the use of non-compete agreements in employment contracts.  The letter further provides a path to achieve the FTC’s objectives while minimizing risks to workers, companies and the economy.

Varnum attorneys are closely monitoring this situation and will be providing updates to our clients as the FTC’s initiative further develops.

Understanding Pre-Money vs. Post-Money Valuation

One of the key points of negotiation in any venture capital financing round is the valuation of the company. Valuation can be determined prior to the investment, called the pre-money valuation, or after the investment is made, called the post-money valuation. Whether a valuation is measured on a pre-money basis or post-money basis has a material effect on the capital effects of the financing round, including pricing for shares issued in the financing round and the scope of dilution borne by current investors.

What Is Pre-Money Valuation?

The pre-money valuation is the valuation used to calculate the per share price of the company’s stock, typically a series of preferred stock, sold in a financing round. As its name suggests, the pre-money valuation does not take into consideration any new money the company will receive in the pending preferred stock financing.

The purchase price for the preferred stock is calculated by dividing the pre-money valuation by the fully diluted capitalization of the company. For example, if the company has a pre-money valuation of $7.5 million and a fully diluted capitalization of five million shares, then it would sell shares of preferred stock in the financing for $1.50 per share. As an example of the post-money effect of this pre-money valuation, consider a scenario in which the investors purchase $2.5 million worth of preferred stock. Those investors will have purchased 1,666,667 shares of the company’s preferred stock, representing 25 percent of the company on a post-closing basis, and resulting in the company having a post-money valuation of $10 million.

How to Calculate a Company’s Fully Diluted Capitalization 

Once the pre-money valuation is set, the main factor affecting the per share price is the calculation of fully diluted capitalization. The fully diluted capitalization of the company typically includes the following:

  • All issued and outstanding shares of the company’s capital stock, including common and preferred stock (or common stock issued upon conversion of preferred stock, if the preferred stock converts to common stock at a ratio greater than 1:1);
  • All capital stock issued upon the conversion or exercise of all the company’s outstanding convertible or exercisable securities, including all outstanding vested or unvested options or warrants to purchase the company’s capital stock; and
  • All common stock reserved and available for future issuance under any of the company’s existing equity incentive plans, including, in some cases, any equity incentive plan created or expanded in connection with the proposed financing round.

Whether or not a new or expended equity incentive plan is included in the fully diluted capitalization is typically a point of negotiation between the company and the lead investor in the financing round (this negotiation is often referred to as the “Option Pool Shuffle”). If a new or expanded pool is included in the fully diluted capitalization, this means that only current stockholders will be diluted by such creation or increase. The inclusion of the new or expanded pool increases the number of shares in the fully diluted capitalization, which functionally decreases the price per share in the financing round. If the new or expanded pool is not included, both current stockholders and investors in the financing round are diluted by the creation or expansion of the pool on a post-closing basis.

What Is Post-Money Valuation?

The post-money valuation is also used to calculate the per share price of the preferred stock sold in a financing round but, as its name also suggests, the post-money valuation takes into consideration the new money the company will receive in the pending preferred stock financing, as well as any outstanding convertible securities, such as SAFEs and convertible notes, converting into shares of preferred stock as part of the financing round.

The post-money valuation then is equal to the company’s pre-money valuation plus the amount invested in the company in the financing round, either in new money or convertible securities. Using the example above, if the company has a post-money valuation of $10 million and the investors propose investing $2.5 million in new money, the functional pre-money valuation of the company is again $7.5 million. If the company has a fully diluted capitalization of five million shares, then it would again sell shares of preferred stock in the financing for $1.50 per share.

However, in this example, if the company also has $1 million in SAFEs and convertible notes converting into shares of preferred stock in the financing round, the functional pre-money valuation of the company is now $6.5 million. If the company has a fully diluted capitalization of five million shares, then it would now sell shares of preferred stock in the financing for $1.30 per share. In this example, notice that the investors investing $2.5 million in new money will still end up with 25 percent of the company on a post-closing basis.

Once the post-money valuation is set, negotiations concerning the calculation of fully diluted capitalization are still relevant, but the main factor now affecting the per share price is the amount of converting securities functionally lowering the valuation. In particular, the valuation caps, discounts and interest rates on such convertible securities can all effect the calculation of the per share price and functionally lower the pre-money valuation.

Seeking a lawyer for your startup? Varnum’s Venture Capital and Emerging Companies Team provides critical guidance and support to entrepreneurs and venture capital professionals throughout all stages of financing and growth. Let us add value to your team as you work to bring your new offering to market.

Navigating the Solar Energy Development Approval Process in Michigan

Michigan’s Renewable Energy Portfolio Standard law (MCL 460.1028) initially set the bar for 15% of the state’s electricity to come from renewable sources by 2021. Though only 11% of the in-state electricity came from renewable energy in 2021, Michigan’s renewable energy ambitions continue to soar. Governor Gretchen Whitmer introduced Michigan’s Healthy Climate Plan (MHCP) in April 2022, targeting 60% of the state’s power to come from renewables by 2030, including a 50% renewable energy standard for utilities. Bolstered by a Democrat-controlled governor and legislature, Michigan has become a hot spot for solar energy projects.

Michigan’s Unique Approval Process

Solar energy projects in Michigan face a unique approval process. In Michigan, local planning commissions and zoning boards, rather than state or county authorities, often regulate solar projects. Solar developers must, therefore, navigate the local master plan, zoning ordinances, politics and public opinion. Solar projects usually require a special land use permit and site plan approval from the local municipality – most typically a township. The general process—though it is township-specific—for obtaining such a permit includes:

  1. Pre-application Meeting: Engage with the township’s planning commission to discuss project details and requirements.
  2. Preliminary Site Plan Preparation: Create a detailed site plan, including project location, layout and relevant assessments.
  3. Permit Application: Submit the special land use permit application and site plan for review to the township.
  4. Planning Commission Review: The commission reviews the application, ensuring compliance with local ordinances and laws.
  5. Public Hearing: Engage in a public hearing to address community concerns.
  6. Approval or Denial: In some townships, the planning commission makes the final decision. In others, the planning commission makes the recommendation to approve or deny and the township board makes the final decision. If denied, developers may revise the project plan or seek legal appeals.

In some townships, solar projects are only permitted in certain zoned districts. In those townships, a rezoning may be required. That process is similar to the special land use approval process but has additional steps and different legal standards for approval. Significantly, a rezoning is subject to referendum if sufficient signatures are obtained in a short timeframe following the rezoning.

However, some townships can be less-than-welcoming to solar projects, actively seeking to prevent solar development. They may adopt moratoria, putting extended pauses on solar project considerations or amend their ordinances with unreasonable setback, size, noise, landscaping, storm water management and location restrictions, rendering projects economically unfeasible. Developers should, therefore, seek legal counsel to help them navigate Michigan’s unique and complex legal landscape.

As lawyers specializing in solar energy projects in Michigan, we offer solar developers guidance through the complex legal terrain of land use, zoning regulations and permits. Please contact your Varnum attorney for more information.