Small Business Tax Act of 1981

Small Business Tax Act of 1981 - Amends the Internal Revenue Code to permit a taxpayer to elect to expense (i.e., currently deduct) up to $25,000 of the costs of new or used tangible personal property used in the taxpayer's trade or business during a taxable year in lieu of current provisions permitting additional first year depreciation.

Reduces the amount of tax imposed on the taxable income of a small business corporation by an amount equal to the tax which would be imposed if such corporation's taxable income for the taxable year equalled the lesser of: (1) the amount of dividends distributed during the taxable year; or (2) $100,000. Excludes certain businesses from eligibility for such treatment.

Allows losses from the sale or exchange of preferred small business stock to be treated as ordinary losses. (Currently such treatment is available only with regard to common stock).

Exempts from income taxation any income resulting from the transfer of stock to an individual exercising a stock option under an incentive stock option plan. Specifies that the optionee may not dispose of stock within two years after an option is granted nor within one year after the transfer of shares. Requires that the optionee be an employee of the corporation granting such option at all times during the period after an option is granted and for three months after such option is exercised.

Defines "incentive stock option" as an option granted to an individual in connection with employment by a corporation to purchase stock of such corporation. Sets forth the following conditions for the granting of such options: (1) the approval of a plan for granting options by the shareholders of the corporation; (2) the granting of options within ten years of either the adoption or approval of the plan; (3) the termination of the option after ten years; (4) an option-price which is not less than the fair market value of the stock subject to such option; (5) the nontransferability of the option; and (6) the optionee may not hold more than ten percent of the stock of the corporation, unless the option price is at least 110 percent of the fair market value of the stock subject to the option and such option is terminable five years after it is granted.

Qualifies estates of decedents who were disabled or retired for the special use valuation if such decedents materially participated in the operation of the farm or business for five out of eight years preceding the year in which they became disabled or eligible for disability benefits, under title II (Old Age, Survivors and Disability Insurance) of the Social Security Act. Permits the spouse of a decedent to use such valuation if the spouse has managed the farm or business for ten years preceding the decedent's death or takes over active management upon the decedent's death. Qualifies the owner of a woodland for the special use valuation if the owner or a member of the owner's family actively managed the property for ten years prior to the owner's death. Reduces from 15 to ten years the length of time a qualified property must be held and put to a qualified use following the decedent's death before it can be disposed of without incurring a recapture of estate tax benefits. Permits active management rather than material participation as a test for qualification of the estate for spouses, children under 21, students, and disabled individuals who receive property from a decedent who qualified for special use valuation.

Allows the like kind exchange of property without loss of special use valuation eligibility.

Eliminates the requirement, for purposes of the formula for valuing farms, that average annual rental amounts be based on cash. Repeals the requirement that an heir elect special treatment for involuntary conversions of qualified real property, thus making such treatment automatic upon such conversion.

Modifies the alternate extension of time for payment of the estate tax where the estate consists largely of an interest in a closely held business to: (1) allow an installment payment election if the value of the interest in the closely held business is either 35 percent of the value of the gross estate or 50 percent of the taxable estate; (2) increase to 50 percent the value of an interest disposed of which will accelerate the payment of tax; and (3) permit payment, but with a penalty, of an installment within six months after the due date.

Provides for an inflation adjustment of the $500,000 limitation on the aggregate decrease in the value of property to which the special use valuation is applied.