To encourage investment in new ventures, small businesses, and specialized small business investment companies, Section 1202 of the Internal Revenue Code grants relief to investors who risk their funds in these businesses.
Depending on the acquisition date of qualified small business stock (QSBS), non-corporate investors may exclude 50/75/100% of gain realized on the disposition of QSBS issued after August 10, 1993 and held more than five years.
QSBS Acquisition Date
|8/11/1993 – 2/17/2009||50%|
|2/18/2009 – 9/27/2010||75%|
The gain eligible to be taken into account for purposes of this exclusion is limited to the greater of $10 million or 10 times the taxpayer’s basis in the stock.
In addition, for dispositions of QSBS that are eligible for this 100% capital gain exclusion, no portion of the excluded gain is treated as a preference item for purposes of the alternative minimum tax (AMT). For dispositions of QSBS that are eligible for the 50% or 75% exclusion (i.e., issued prior to September 28, 2010), a portion of any excluded gain will continue to be treated as a preference item.
- The stock must be “originally issued” to the taxpayer by a U.S. corporation that is a qualified small business on the date of issuance.
- During substantially all of the taxpayer’s holding period, at least 80% (by value) of the corporation’s assets must be used in the active conduct of one or more qualified trades or businesses (ToB). See more on this below*.
- The corporation must be an “eligible corporation” during substantially all of the taxpayer’s holding period.
- The corporation may not (directly or indirectly) redeem more than a de minimis number of shares held by a taxpayer to which the QSBS is issued, or certain related parties, within a four-year period beginning two years prior to the issuance of the QSBS.
- There may be no “significant redemptions” of the issuing corporation’s stock from any party during the two-year period beginning one year prior to the QSBS’ issuance.
- any trade or business involving the performance of services in 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 one or more of its employees
- any banking, insurance, financing, leasing, investing, or similar business
- any farming business (including the business of raising or harvesting trees)
- any business involving the production or extraction of products of a character with respect to which a deduction is allowable under section 613 or 613A
- any business of operating a hotel, motel, restaurant, or similar business
- The partnership satisfies the five-year holding period described above
- The noncorporate partner held its interest in the partnership on the date on which such pass-thru entity acquired such stock and at all times thereafter until the disposition of such stock.
See the full text of IRC Section 1202 here.