What is Section 1202 Small Business Stock?

small business stock

According to section 1202 of the internal revenue code (IRC), “the term ‘qualified small business stock’ means any stock in a C corporation which is originally  issued  after the date of the enactment of the Revenue Reconciliation Act of 1993 if (A) as of the date of issuance, such corporation is a qualified small business, and (B) except as provided in subsections (f) and (h), such stock is acquired by the taxpayer at its original issue (directly or through an underwriter)— (i) in exchange for money or other property (not including stock), or (ii) as compensation for services provided to such corporation (other than services performed as an underwriter of such stock).” 

I.R.C. § 1202(c)(1)

It is the following specifications that are the most important when considering if your stock meets the standards of QSBS:

  • The company must be a domestic C corporation.
  • The aggregate gross assets may not exceed, at any point in the past, or immediately after issuance, $50M.
  • The company must be involved in a qualified trade or business which includes anything except “the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees, any banking, insurance, financing, leasing, investing, or similar business, or any farming business, and any business of operating a hotel, motel, res­taurant, or similar business.
  • The corporation must be a qualified small business at the date of issuance of the stock.
  • The stock is acquired by the taxpayer directly from the corporation.
  • The taxpayer must hold the stock for a minimum holding period of 5 years.
  • During “substantially all” of the taxpayers holding period, the corporation must be an active business.

Why Is it Important To Identify Qualified Small Business Stock?

The ability to understand if your stock fits the bill of QSBS could mean tax-free gains for shareholders of up-to $10,000,000 or 10x the adjusted basis of the stock, whichever is greater.

The original benefit of QSB stock was that a taxpayer could exclude 50% of capital gains resulting from the sale of eligible stock up to $10,000,000 or 10X the adjusted basis of the stock, whichever is greater.

Thanks to the American Taxpayer Relief Act of 2012, approved by congress under the Obama administration, investors can now look forward to a possible 75% or even 100% exclusion on capital gains up to the same threshold mentioned above. 

Check out the chart below to see what amount of benefits you could claim depending on when you purchased your eligible QSB stock.

Date AcquiredAllowable ExclusionNon-QSBS ExampleQSBS Example
after December  31, 199350%Capital Gain: $1MTaxes Owed: $200KCapital Gain: $1MTaxed: $100K
between February 17, 2009 & September 26, 201075%Capital Gain: $1MTaxes Owed: $200KCapital Gain: $1MTaxes Owed: $50K
after September 27, 2010100%Capital Gain: $1MTaxes Owed: $200KCapital Gain: $1MTaxes Owed: $0
*The examples above are based on an individual making over $400K and the associated tax bracket on capital gains.

This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.

About QSBS Expert

QSBS Expert was founded by a group of entrepreneurs, investors, accountants and lawyers who came together when trying to navigate a QSBS situation of their own. We quickly realized that the regulations left a lot of open questions and the publicly available information was confusing to sift through…so we thought that others may also benefit from having a “go to” resource for all things QSBS.