As a holder of qualified small business stock (QSBS), it is important to know what steps to take not only when you report the Section 1202 exclusion on your taxes but also when the QSBS is issued. QSBS for some is a hidden secret embedded within the internal revenue code that can be the silver bullet to significant federal and potentially state capital gains tax savings.
Given the complexities in the application of these tax exclusions, the likelihood of an audit may be increased. As such, it is imperative to ensure you have thorough documentation in your tax file, including items such as:
- Articles of Incorporation
- Stock Purchase Agreement
- At issuance: Tax Opinion Letter regarding classification of holdings as QSBS
- At sale: Tax Opinion Letter regarding evaluation and quantification of QSBS exclusion
- A Stock Sale Agreement
Depending on how the QSBS was acquired (e.g. through a pass-through entity such as an investment fund, purchased directly from the Qualified Small Business entity, etc.), you may receive different forms / statements or no form at all. Typically, QSBS will be reported on one of the following forms:
- Form 1099-B: Sold through a broker
- Form 1099-DIV: Distributions from a financial institution
- Form 1099-CAP: Control of the Qualified Small Business was acquired
- Form 1099-MISC:Unusual to receive but could happen (e.g. Corporation repurchases issued QSBS)
- Schedule K-1: QSBS is owned through a pass-through entity
Next, determine what your excludable gain is based on the year it was purchased (e.g. 50%, 75%, or 100%) and the tax exclusion cap (i.e. $10 million or 10x the initial investment) to report on the forms below.
- Form 8949 (applicable in all cases)
- Schedule D (applicable in all cases)
- Form 1045 (applicable in all cases)
- Form 6251(if purchased before September 27, 2010)
- Form 8960(if there is a portion of the gain that is not excludable)
While Section 1202 gain only takes a few steps to report on your tax return but it is important the correct documentation collected to (i) determine the right gain exclusion and (ii) have tangible proof that the stock does qualify as QSBS.
Note: The documentation needed and filing instructions will change if your QSBS was acquired through a Section 1045 rollover, which is outside the purview of this document.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.