Per Diem Rates from the U.S. General Services Administration
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Excluding Gain on Qualified Small Business (QSB) Stock (Section 1202)
Tax policy is enacted for a variety reasons. Sometimes with a social purpose in mind, such as a tax on cigarettes to encourage people to stop smoking. Other times, tax policy has an economic purpose in mind, such as encouraging investment in small businesses. This is the purpose of the Section 1202 gain exclusion.
Background of Sec. 1202
Before Feb. 18, 2009:
Prior to Feb. 18, 2009, the gain exclusion under Section 1202 was 50% of capital gains from gross income.
Feb. 18, 2009 through Sept. 27, 2010:
The American Recovery and Reinvestment Act increased the gain under Section 1202 from 50% to 75% for stocks purchased between Feb. 18, 2009 and Sept. 27, 2010. This was done to stimulate the small business sector. For small business stocks that are eligible for the 50% or 75% exclusion, a portion of the excluded gain was subject to an additional 7% Alternative Minimum Tax (AMT).
After Sept. 27, 2010
The latest amendment to section 1202 provides for the following:
- 100% exclusion of any capital gains if the acquisition of the small business stock was after Sept. 27, 2010.
- No portion of the excluded gain is a preference item for AMT purposes.
- The capital gains that are exempt from tax under section 1202 are also exempt from the 3.8% net investment income tax applied to most investment income.
- The amount of gain that any investor can exclude under Section 1202 is limited to a maximum of the GREATER OF:
- $10 million or
- 10 times the adjusted basis of the stock.
The taxable portion of a gain from selling a small business stock has an assessment at the maximum tax rate of 28%. You must hold the stock over five years to qualify for the gain exclusion (the idea is to encourage investment and not speculation).
Requirements of Section 1202
Not all small business stocks are qualified for tax breaks under the IRC. The Code defines a small business stock as qualified if:
- It was issued by a domestic C-corporation other than a hotel, restaurant, financial institution, real estate company, farm, a mining company, or business relating to law, engineering, or architecture.
- It was originally issued after August 10, 1993, in exchange for money, property not including stocks, or as compensation for a service rendered.
- On the date of stock issue and immediately after, the issuing corporation had $50 million or less in assets.
- The use of at least 80% of the corporation’s assets is for the active conduct of one or more qualified businesses.
- The issuing corporation does not purchase any of the stock from the taxpayer during a four year period beginning two years before the issue date.
- The issuing corporation does not significantly redeem its stock within a two-year period beginning one year before the issue date. A significant stock redemption is redeeming an aggregate value of stocks that exceed 5% of the total value of the company’s stock.
States that conform to federal tax rules will also exclude the capital gains of small business stock. However, not all states conform with federal tax rules, therefore, taxpayers should seek guidance from their tax professional to determine their state's tax treatment of realized profits from the sale of qualified small business stocks.