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How To Avoid Millions of Dollars In Capital Gains Tax By Using The Qualified Small Business Stock Exclusion
Most entrepreneurs don’t know of a simple way to avoid millions of dollars in capital gains tax. Section 1202 of the Internal Revenue Code grants non-corporate taxpayers a tax break of up to $10,000,000 in capital gains on “qualified small business stock” that the taxpayer holds for more than five years. This is a huge exclusion. I believe all entrepreneurs should have a basic grasp on Section 1202’s high-level requirements so that they can take full advantage of its tax breaks. So, here they are.
What Are The Requirements for Capital Gains Tax deductions?
C-Corporation for Capital Gains Tax Deductions
In order to qualify for, capital gains tax deductions, the issuer of the stock must be a C-corporation. S-Corporations or LLCs taxed as partnerships do not qualify. Founders should consider this in particular when choosing an entity.
Less Than $50,000,000 in assets
The issuer must have less than $50,000,000 in aggregate gross assets before and immediately after you receive your shares.
80% of Assets Used
The issuer must use at least 80% of its assets in the active conduct of its Qualified Trade or Business (more on that below).
Issued After August 10, 1993
The company must have issued the stock after August 10, 1993.
Original Issuance
Generally for, capital gains tax deductions, you must acquire the stock directly from the company. This becomes more complicated if you receive equity compensation, like options or restricted stock, or if you hold convertible debt or a warrant.
Domestic Corporation
The company must be organized in the United States.
Qualified Trade or Business
The issuer’s business not be any of the following. I generalized the descriptions below for simplicity’s sake.
- Professional services
- Financial services
- Farming
- Mining
- Hospitality
Five Year Holding Period
You must hold the stock for more than five years before you sell it for capital gains tax deductions. This also begins becomes more complicated if you receive equity compensation, like options or restricted stock, or if you hold convertible debt or a warrant. This will also become more complicated if a company began as an LLC, and converted into a C-corporation.
In Exchange for Money or Other Services
The company must issue the stock in exchange for money or other services. If the company issues the stock in exchange for other stock, it won’t count.
Conclusion:
This post is just a summary, and Section 1202 can get complex quickly depending on the situation.
Carney Badley Spellman is about Advocacy, Strategy, Results. Located in Seattle, we are a full-service law firm committed to exceptional client service and professional excellence. Our firm serves individuals, professionals, entrepreneurs, educators, closely-held or family businesses, franchises, Fortune 500 corporations, and insurance companies. They are in the private sector, public sector, and governments. Our clients are forward thinkers, creative, collaborative, and deliver high-quality products and business services to their markets. Their markets extend into almost every industry including, food and beverage, retail, professional services, arts, health care, education, manufacturing, technology, construction, real estate, and more. We advocate for our clients. We strategize with them to meet their goals.[/vc_column_text][/vc_column][/vc_row]
