Facebook's decision to go public has been big news, with the value of the social-networking giant soaring to over $100 billion.

Early investors and employees with stock options are looking at large gains when they decide to sell their stock, leaving lawmakers giddy thinking about the anticipated tax haul. Reuters reported that California lawmakers are already drawing up plans for spending the revenue generated by those selling their Facebook shares.

These early investors and Facebook employees could benefit from Internal Revenue Code Section 1202, which provides a partial exclusion for gain from the sale of certain small-business stock.

Facebook a small business? Absurd, yet the Section 1202 definition of "small" may surprise you.

Generally, stock is classified as small-business stock if the following conditions are met:

The issuing corporation must be a domestic C corporation.

Stock must be issued after Aug. 10, 1993.

Stock must be acquired by the taxpayer at its original issue in exchange for money, property, or as compensation for services.

Aggregate gross assets of the corporation both before and immediately after shares were acquired did not exceed $50 million.

AGA means the cash plus the total adjusted book basis (not fair market value) of other property held by the corporation. The book basis of the company at the time early investors bought in, or stock options were acquired, could very well have been below the $50 million mark.

Under Internal Revenue Code Section 1202, certain non-corporate taxpayers can exclude from income 50 percent of the gain from the sale or exchange of qualified small-business stock held for more than five years. For most taxpayers, a federal Alternative Minimum Tax adjustment eliminates the benefit of the 50 percent exclusion.

California has its own version of IRC Section 1202, similar to the federal exclusion. However, California also requires that the following conditions be satisfied:

At least 80 percent of the corporation's payroll, measured by total dollar value, must be attributable to employment located within California; and,

At least 80 percent (by value) of the assets of the corporation must be used by the corporation in the active conduct of one or more qualified trades or businesses in California.

These two 80 percent requirements (both payroll and assets in California) must be met during "substantially all" of the taxpayers' holding period.

California corporations that meet this definition of a small business are supposed to file a Form FTB 3565, Small Business Stock Questionnaire, with the Franchise Tax Board and mail copies to each of their shareholders. If a corporation does not file, the stockholders can still claim the exclusion, but they must prove that the stock satisfies the requirement.

We have been unable to determine if Facebook meets this 80 percent requirement for California purposes. If you have stock in Facebook, and received a copy of the FTB 3565, then it would appear it does.

Those who are holding some of these early shares and facing these huge gains may want to talk with a tax professional to minimize the potential tax impact.

Barbara Rosenbaum is a senior tax shareholder and Lori Shrout is a manager at CPA and business advisory firm Gumbiner Savett.

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