A 15-year old capital gains tax break intended to benefit small businesses and start-up firms has caught the attention of Senator Barack Obama.  Obama has expressed an interest in expanding the 1993 provision by eliminating the capital gains taxes for certain companies.  The proposal is beginning to get renewed interest on both sides of the political aisle, with legislation introduced in both chambers to accomplish Obama’s goal in one form or another.

The provision was originally enacted as part of the 1993 budget agreement.  Congress created a 50 percent exclusion from gross income of capital gains tax from the sale of stock held for at least five years in small companies (those classified as having assets of $50 million or less).  The recent Senate GOP tax extenders bill introduced by Senate Minority Leader Mitch McConnell (R-Kentucky), the ranking member of the Senate Finance Committee, Senator Charles Grassley (R-Iowa) and others earlier this month, would bump up the exclusion to 100 percent, effectively creating a zero percent capital gains rate for small-business stock gains.

The provision would be effective upon enactment and apply through the end of 2010, at a cost of $3.95 billion over 10 years, according to preliminary estimates.  The proposal assumes that taxpayers would respond by increasing holdings of small company stock.

In the U.S. House of Representatives, newly elected Congressman Travis Childers (D-Mississippi) introduced a version of legislation to eliminate capital gains taxes on small company stock sales.  The Childers bill is more expansive and expensive because it would decrease the amount of time a taxpayer would have to hold the stock from five to three years.  It would double the qualifying income limit to cover businesses worth up to $100,000.  It would also allow corporations to benefit, provided they hold no more than a 25 percent stake in a small business firm’s stock.

However, it is important to note that Senator Obama backs raising the capital gains rate to 25 percent, while taxing “carried interest” or income earned from investment partnerships, at regular income rates of as high as 35 percent as opposed to the current 15 percent capital gains rate.  Some see the carried interest plan as stifling investment and innovation, with some investors not seeing a payoff for seven to 10 years deciding it’s not worth the wait if their income will be taxed at the higher rate.