Section 1202 explained

Section 1202 of the Internal Revenue Code (IRC) is a tax provision that provides certain tax benefits to investors in qualified small business stock (QSBS). This provision was created to incentivize investment in small businesses and promote economic growth.

What is QSBS?

Qualified small business stock refers to shares of stock in a domestic C corporation that meets certain criteria. To qualify as QSBS, the stock must be acquired directly from the issuing corporation in exchange for money, property, or services. Additionally, the corporation must be an eligible small business (ESB) at the time of issuance.

Tax Benefits of Section 1202

One of the key benefits of Section 1202 is the potential for exclusion of gain on the sale of QSBS. If certain requirements are met, taxpayers may be eligible to exclude a portion or all of the gain realized from the sale of QSBS from their taxable income. This exclusion can be significant, as it allows investors to potentially reduce their tax liability.

Requirements for Exclusion

To qualify for the exclusion under Section 1202, the following requirements must be met:

• The stock must be acquired at original issuance from a qualified small business
• The stock must be held for at least five years
• The corporation must meet the criteria to be considered an eligible small business

Limitations on Exclusion

While Section 1202 offers significant tax benefits, there are limitations to consider. The amount of gain eligible for exclusion is subject to a cap based on the greater of $10 million or 10 times the taxpayer's basis in the QSBS. Additionally, certain types of corporations, such as those engaged in professional services or finance, do not qualify for the exclusion.

Recent Changes to Section 1202

The Tax Cuts and Jobs Act (TCJA) made several changes to Section 1202. Prior to the TCJA, the exclusion percentage for QSBS was 50% or 75% depending on the acquisition date. However, under the TCJA, for stock acquired after September 27, 2010, the exclusion percentage is generally increased to 100%.

Consult a Tax Professional

Section 1202 can be complex, and the specific tax benefits and requirements may vary depending on individual circumstances. It is important to consult with a qualified tax professional to understand how Section 1202 applies to your specific situation and to ensure compliance with the IRC.

In Conclusion

Section 1202 of the IRC provides tax benefits to investors in qualified small business stock. By meeting certain requirements, investors may be eligible to exclude a portion or all of the gain realized from the sale of QSBS from their taxable income. However, it is crucial to consult with a tax professional to fully understand the provisions and limitations of Section 1202.