what is section 1202 qualified small business stock

by Prof. Herta Gusikowski Published 3 years ago Updated 2 years ago

Qualified small business stock is a provision in the tax code (U.S. Code Section 1202) that provides some tax benefits for individuals that invest in early-stage companies. The provision has been in our tax code since 1993. It’s only become well known in the last year or so because, historically, it didn’t provide a material tax benefit.

Section 1202, also called the Small Business Stock Gains Exclusion, is a portion of the Internal Revenue Code (IRC) that allows capital gains from select small business stock to be excluded from federal tax. Section 1202 of the IRS Code only applies to qualified small business stock acquired after Sept.

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Does your small business qualify for the section 1202 exclusion?

Aug 11, 1993 · The “qualified small business stock” (QSBS) tax exemption under Section 1202 [1] allows non-corporate founders and investors in certain emerging growth companies to potentially exclude up to 100% of the U.S. federal capital gains tax incurred when selling its stake in the start-up or small business. Section 1202 (a) permits a stockholder to exclude a …

How to report 1202 gain?

Jun 22, 2021 · According to section 1202 of the internal revenue code (IRC), “ the term ‘qualified small business stock’ means any stock in a C corporation which is originally issued after the date of the enactment of the Revenue Reconciliation Act of 1993 if (A) as of the date of issuance, such corporation is a qualified small business, and (B) except as provided in subsections (f) …

What is section 1202 stock?

That’s what can happen with qualified small business stock (QSBS). Also referred to as Section 1202 stock because that’s the section in the Tax Code that governs it, QSBS can be a significant planning tool for the right company, such as a tech startup.

What is section 1202 property?

Aug 03, 2021 · Section 1202, or qualified small business stock gain exclusion, has become a go-to tax planning strategy. Learn more to make sure you’re not missing out. Until recently, many taxpayers were unaware of a tax incentive for sellers of qualifying C corporations, but tax changes in the past several years have made this a go-to tax planning strategy that can create massive …

What is qualified small business stock?

Qualified small business stock (QSBS) refers to shares of a qualified small business (QSB) as defined by the Internal Revenue Code (IRC). A QSB is an active domestic C corporation whose gross assets—valued at the original cost—do not exceed $50 million on and immediately after its stock issuance.

How do you qualify for 1202?

Qualified small business: The C corporation must be a qualified small business, as defined under section 1202, during substantially all of the taxpayer's QSBS holding period. Gain Exclusion: The amount of gain exclusion is equal to the greater of $10 million or 10 times the basis in the taxpayer's QSBS.29 Sept 2021

What is a 1202 gain and how is it taxed?

Section 1202 was enacted in 1993 to encourage investment in small businesses. It allows individuals to avoid paying taxes on up to 100% of the taxable gain recognized on the sale of qualified small business corporation stock (sometimes referred to as QSBS).3 Aug 2021

Is 1202 stock subject to AMT?

Section 1202 provides for a lower percentage of exclusion (generally 50% or 75%) for QSBS issued prior to September 28, 2010. The amount of gain that is not excluded is generally taxed at a 28% rate and is also subject to the NIIT. The excluded portion of any gain is treated as a preference item for AMT purposes.7 Oct 2020

Can LLC qualify for 1202?

Partners in a partnership (including an LLC electing partnership status for federal tax purposes) operating a business are not eligible for the section 1202 gain exclusion upon the sale or exchange of their partnership interest.26 Jul 2021

How do I report a section 1202 stock?

Form 1099-DIV: Section 1202 gain will appear in box 2(c) of the form and will be reported on Schedule D, line 13, of your individual tax return.17 Feb 2021

Is qualified small business stock subject to AMT?

In 2009, Congress temporarily increased the gain exclusion from 75 percent to 100 percent for QSBS acquired after September 27, 2010, and then made the 100 percent exclusion permanent in 2015. This change also eliminated the 28 percent tax rate and AMT effect, which increased the tax savings and popularity.26 Jul 2021

Is 1202 going away?

The amendment to Section 1202 would be effective for sales and exchanges of QSBS occurring on or after September 13, 2021, subject to a binding contract exception for contracts in effect prior to September 13, 2021.3 Nov 2021

Why Is it Important To Identify Qualified Small Business Stock?

The ability to understand if your stock fits the bill of QSBS could mean tax-free gains for shareholders of up-to $10,000,000 or 10x the adjusted basis of the stock, whichever is greater.

About QSBS Expert

QSBS Expert was founded by a group of entrepreneurs, investors, accountants and lawyers who came together when trying to navigate a QSBS situation of their own.

What to do if you have a C corporation?

If you have a C corporation or are thinking of forming one and you are in an eligible industry described earlier, consider using qualified small business stock to raise capital or compensate key employees. Talk to a tax advisor to make sure that all conditions for being a qualified small business are met before you proceed.

Who is Barbara Weltman?

Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser's Small Business Taxes, J.K. Lasser's Guide to Self-Employment, and Smooth Failing as well as a trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for three years in a row. Follow her on Twitter: @BigIdeas4SB or at www.BigIdeasforSmallBusiness.com

Is QSBS taxable?

When issuing QSBS that does not have any restrictions, there are still payroll tax costs to the company. The value of the stock, which is equal to the compensation that would have been paid instead for the services performed, is taxable compensation to employee.

Is a corporation a holding company?

The corporation must be an active business (not a holding company) at all times that the stock is held. The corporation must be in a business other than one involving personal services; banking, insurance, financing, leasing, or investing; farming; mining; or operating a hotel, motel, or restaurant. Essentially, then, permissible businesses include ...

What is the IRS section 1202?

Section 1202, also called the Small Business Stock Gains Exclusion, is a portion of the Internal Revenue Code (IRC) that allows capital gains from select small business stock to be excluded from federal tax. Section 1202 of the IRS Code only applies to qualified small business stock acquired after Sept.

What is AMT in tax?

AMT is usually imposed on individuals or investors who have tax exemptions that allow them to decrease the income tax paid. The latest amendment to Section 1202 provides for 100% exclusion of any capital gains if the acquisition of the small business stock was after Sept. 27, 2010.

What is the Path Act?

The PATH Act renews some expired tax provisions for a couple of years and permanently extends some tax benefits. One tax break, made permanent by the Obama administration, is the Small Business Stock Capital Gains Exclusion found in Section 1202 of the Internal Revenue Code.

Who is Will Wills?

He developed Investopedia's Anxiety Index and its performance marketing initiative. He is an expert on the economy and investing laws and regulations. Will holds a Bachelor of Arts in literature and political science from Ohio University. He received his Master of Arts in economics at The New School for Social Research.

What is the qualified small business stock gain exclusion, also known as Section 1202?

Example: The tax savings are out there

Fox Mulder was issued stock in Spooky, Inc. on Jan. 1, 2011, in exchange for $2 million in cash. On June 1, 2016, Fox sold the stock for $22 million, realizing a $20 million gain.

Requirements to qualify for Section 1202 gain exclusion

Stock must meet eight requirements to qualify for Section 1202 benefits. While each requirement has some nuances that can’t be taken at face value, below is a high-level overview of each of these requirements. Some of these are determined by the shareholder, while others are determined based on facts and activities of the corporation.

How we can help

Whether you’re starting a new venture, planning for a future exit transaction, or you’ve already sold your stock, it’s important that you have all the information you need to claim the Section 1202 exclusion and support the position if challenged by the IRS.

What is the 1202 requirement?

In general, section 1202 has requirements that apply to the company issuing the stock, and requirements that apply to the shareholder selling the stock and hoping to qualify for an exclusion under section 1202. On the issuer side, the requirements are as follows:

What is shareholder requirement?

On the shareholder side, the requirements are as follows: The shareholder must be an individual, trust, estate, partnership, S corporation, mutual fund, or common trust fund.

What is QTB in tax?

The company must be engaged in a qualified trade or business (QTB) during “substantially all” of the taxpayer’s holding period. A QTB is any trade or business other than certain excluded businesses.

What is the PLR 202114002?

Given the sparse amount of guidance to date, it is noteworthy when the IRS issues something. On April 9, 2021, the IRS released a favorable private letter ruling ( PLR 202114002) discussing what it means to be engaged in the brokerage business, an excluded business. It ruled that an insurance agent or broker is not engaged in the business ...

Is a private letter ruling binding?

Although any guidance under section 1202 is welcome guidance, private letter rulings are only binding on the IRS with regard to the specific taxpayer that requested the ruling. They are helpful to other taxpayers only insofar as they provide an indication of the IRS’s position on the legal issues addressed.

What is QSBS gain exclusion?

Gain Exclusion. Gain from the sale of QSBS is eligible for 100% exclusion from U.S. federal capital gains tax (or a lower percentage as described below), as well a corresponding 100% exclusion from the alternative minimum tax (AMT) and 100% exclusion from the 3.8% net investment income tax (NIIT).

What is QSBS exemption?

The “qualified small business stock” (QSBS) tax exemption under Section 1202 [1] allows non-corporate founders and investors in certain emerging growth companies to potentially exclude up to 100% of the U.S. federal capital gains tax incurred when selling its stake in the start-up or small business. Section 1202 (a) permits a stockholder ...

How to qualify for QSBS?

Stock of a small business may qualify as QSBS if a number of requirements are met, including: 1 the stock is issued to a non-corporate stockholder (individual or pass-through, including an LLC taxed as a partnership or S-corporation); 2 the small business is a domestic eligible C corporation at the time the stock is issued; [3] 3 the stock is acquired directly from the small business at its “original issuance” in exchange for money or other property (not including stock) or as compensation for services; [4] 4 during substantially all of the time the stockholder holds the stock, the small business is engaged in a qualified trade or business and uses 80 percent (by value) of its assets in the active conduct of one or more qualified trades or businesses (as defined below); 5 the small business’s aggregate gross assets [5] from inception to the date the stock is issued (including proceeds received in exchange for the stock) is $50,000,000 or less; 6 with certain de minimis exceptions, the small business has not made any repurchases of stock from any of its stockholders within the two-year period starting one year prior to the date the stock was issued; and 7 with certain de minimis exceptions, the small business has not repurchased any stock from the taxpayer claiming the QSBS gain exclusion or related parties within the four-year period starting two years prior to the date the stock was issued.

What is the 1045 provision?

The provisions under Sections 1045 and 1202 can provide an excellent tax planning tool for non-corporate founders or investors forming or investing in small businesses. Assuming the rules described above are satisfied, the potential 100% capital gains exclusion along with the exclusions for NIIT and the AMT provide a significant tax incentive. Moreover, the rollover rules under Section 1045 provide flexibility in the event an investor must exit earlier than the five-year holding period.

Is a small business a C corporation?

the small business is a domestic eligible C corporation at the time the stock is issued; [3] the stock is acquired directly from the small business at its “original issuance” in exchange for money or other property (not including stock) or as compensation for services; [4]

What is NIIT on 1040?

Net investment income tax ( NIIT) is a 3.8% tax owed when a taxpayer’s modified adjusted gross income (MAGI) exceeds a threshold amount. MAGI is adjusted gross income (AGI) from line 8 (b) on the face of Form 1040. AGI is calculated by taking gross income minus deductions. MAGI is AGI plus any foreign income tax exclusions taken (e.g. exclusions from Section 2555 or any CFCs & PFICs owned). Below are the MAGI thresholds if NIIT must be filed.

What is Form 8949?

Form 8949 is the first form to fill out when reporting a gain on the sale or exchange of Section 1202 QSBS. On page 2 part II of the form the under long-term transactions the Section 1202 gain and exclusion are reported.

Who is Brett Calhoun?

Brett Calhoun is a licensed CPA/ABV and holds an MBA from the University of Missouri. Mr. Calhoun has experience as an operator with startups, venture capital experience, and experience advising growth to mature companies’ management on financial reporting, tax, and valuation issues.