Are you looking for a way to invest in our economy and help small businesses grow? Well, you are in luck, the IRS likes investors like you and has provided some great benefits for your tax planning. Below we present a brief overview of one benefit of investing in small business, known as 1202 stock or Small Business Stock Gain Exclusion. Please feel free to contact us if you would like a more in-depth conversation about the topic.
Sec. 1202: Small Business Stock Gain Exclusion
In order to stimulate investment in small businesses, Congress has created certain exemptions from the sale of specific types of stock. In December of 2015, the PATH Act was signed into law, permanently extending the 100% capital gain exclusion relation to gain realized on certain dispositions of Qualified Small Business Stock (QSBS) acquired after September 27, 2010.
For taxpayers who are not corporations, Sec. 1202 excludes from gross income at least 50% of the gain recognized from sale or exchange of qualified small business stock. However, there are some exceptions.
What is Qualified Small Business Stock?
In order to qualify as a QSBS, the following criteria must be met:
- The stock must be issued by a domestic C corporation with no more than $50 million of gross assets at the time of issuance and immediately after and acquired by the taxpayer as the time of original issuance.
- The stock must have been originally issued after August 10th, 1993 in exchange for money (excluding stock), compensation or services (excluding underwriting).
- The stock must have been held for more than 5 years.
- The stock must have been issued by a corporation that uses at least 80% of its assets (by value) in active business or trade, with the exception of certain personal services and other business types.
- The C Corporation and shareholders must consent to supply documentation regarding QSBS.
How much is excluded?
The maximum exclusion for a taxable year shall be limited to the greater of 10 times the aggregate adjusted basis of the QSBS or $10,000,000. This limitation is computed on a per-issuer basis, with lower limits applying to married individuals filing separately.
The anticipated exception for QBSB is in the table below:
|Acquisition Date||Exclusion Percentage|
|Between 2/18/2009 and 9/27/2010||75%|
In addition, for QSBS acquired after September 28, 2010, no portion of the excluded gain is treated as a preference item for the calculation of alternative minimum tax. Further, some QSBS of small businesses, which satisfy the empowerment zone rules during substantially all of the taxpayer’s holding period, have a 60% exclusion. The stock must have been acquired before Dec. 21, 2000 and sold before 2015.
What is a Qualified Business?
Qualified trade or business does not include trade or business involving the performance of services in the areas of law, health, engineering, architecture, actuarial science, accounting, performing arts, athletics, consulting, or any other trade or business where the principal asset traded is one’s reputation or skill. Real estate investment trusts, investment companies, etc. are also excluded.
Stock held less than 5 years
QSBS stock held more than 6 months but less than 5 years may be rolled over under Sec. 1045. This is an elective rollover of the gain and replacement QSBS stock (which must meet the same qualifying criteria) must be acquired within 60 days from the date of sale.
Massachusetts 1202 Stock Exclusion
Beginning January 1, 2011, gain from the sale of QSBS stock in certain Massachusetts-based start-up corporations are taxed at a rate of 3%, instead of 5.15%. The criteria are as follows:
- Investments must have been made within 5 years of the corporation’s date of incorporation and must be in QSBS stock, “without regard to the requirement that the corporation be a C corporation;
- The stock must be held for 3 years;
- The business must be domiciled in Massachusetts and incorporated on or after January 1, 2011;
- Business must have less than $50 million in assets at the time of investment and
- Must meet the same active business criteria of the IRC Sec. 1202.
Please do not hesitate to reach out with any questions related to Section 1202 stock and how the tax benefits outlined in this article may impact your personal situation. Consult with us to maximize your opportunity to take advantage of these tax benefits!