What Is Section 1202 Qualified Small Business Stock?

The Qualified Small Business Stock, also known as Section 1202, is a part of the Internal Revenue Code (IRC) that allows capital gains from qualified small businesses to be exempt from federal taxes. There are a few limitations, one being that the exemption only applies if you acquired the small business stock after Sept. 27, 2010, and is held for over five years. 

The Qualified Small Business Stock aims to encourage non-corporate taxpayers to invest in small businesses. When you invest in small business stock, you may avoid paying taxes on the capital gains you receive from selling qualified small business corporation stock. Another important factor is that a business can still be large and qualify as a small business. While you may want to take advantage of an incredible opportunity, you’ll need to understand the qualifications of the Section 1202 QSBS. 

What Are the Requirements for Section 1202?

Many wish to take part in the incredible opportunity Section 1202 allows. However, not all small business stocks qualify under the IRC for tax breaks. Consider the following requirements:

Shareholder-Level Requirements

The requirements for Section 1202 are split into two categories. Reviewing the requirements for both is essential for qualifying for the QSBS.

  • An eligible shareholder must hold stock: An eligible shareholder is a non-corporate shareholder, including trusts, estates, and individuals. If a shareholder is a partner or a major corporation, they must meet additional requirements before claiming the benefits of Section 1202.
  • Must hold stock for more than five years: The date on which the stock is issued, or there’s an exchangement is generally when the stock’s holding period begins. After the five-year mark, individuals may dispose of their shares and claim benefits. 
  • Must purchase stock from the original issuance: Rather than purchasing the stock from another shareholder, you must acquire the stock from the company. However, the stock does not have to be issued from the initial incorporation, and those given as compensation for services also can qualify for QSBS.

If you are questioning whether you have completed the qualifications or if there is a specific question relating to your situation, speak with a lawyer. They will be able to answer your questions.

Corporation-Level Requirements

The second category of requirements an individual must meet to qualify for Section 1202 benefits falls under the corporate level. Consider the following:

  • Eligible corporation: Any domestic C corporation with a few exceptions is classified as an eligible corporation, as well as an LLC that elects to be taxed as a C corporation. While the corporation and its subsidiaries may have domestic and international activities, the corporation must be domiciled in the United States. 
  • Limitation of $50 million gross assets: Between Aug. 11, 1993, immediately after the stock issuance, the corporation must not have had more than $50 million of the tax basis in its assets at any time.
  • Redemption transactions: The main goal for Section 1202 is to encourage investment in small business corporations. In order to prevent using invested capital for finding redemptions of other shareholders, Congress disqualifies stock issued shortly before or after redemption of stock.
  • Engaged in a qualified trade or business: A wide variety of industries and businesses are listed, leaving much room for taxpayer interpretation. Some industries that qualify include personal services, finances, and real estate.  
  • Corporation must be an active business: A company must use at least 80% of the fair market value of its assets in active conduct. The individual must continue with this requirement throughout the taxpayers’ holding period.

In order to learn more about the specifics of Section 1202, it’s best to speak with a knowledgeable lawyer with experience handling the process of a QSBS. 

Contact Jeffrey Cardon for a Professional Pleasant Grove Trusts Lawyer

With 15 years of experience in law and a background in entrepreneurial work, Jeffrey Cardon has the knowledge and resources to answer all your questions. Our Cardon Law team provides clients with responsiveness and guidance on growing businesses and facilitating transactions. 

We work with many individuals, from small business owners to high-end executives, to offer professional legal advice. Speak with Jeffrey Cardon by filling out our contact form or calling (801) 225-6700 today.