With some advance planning, certain business owners (other than corporations) can achieve substantial tax savings on cash sale proceeds by structuring the transaction as a sale of “qualified small business stock” (commonly referred to as “QSBS,” for short, or as “1202 stock” because it is governed by section 1202 of the Internal Revenue Code of 1986, as amended (the “Code”).
Tax savings from the sale of QSBS
Section 1202 of the Code allows a percentage of the gain from a sale of QSBS (the “Gain Exclusion Percentage”) that has been held for specified minimum holding periods to be excluded from gross income.
The Gain Exclusion Percentage can be as high as 100% and depends on when the stock was acquired (or, in certain cases involving specified transfers, treated as acquired) and how long it has been held.
For a given tax year, the QSBS exclusion is generally capped at the greater of (1) a specified dollar amount (the “Fixed Dollar Cap”) (which is reduced by the amount of the taxpayer’s prior excluded QSBS gains with respect to such corporation) and (2) ten times the shareholder’s aggregate adjusted basis in the QSBS sold in such year.
These limitations are applied on a per-shareholder, per-corporation basis.
The following table summarizes the interplay between the shareholder’s acquisition date, the Fixed Dollar Cap, Gain Exclusion Percentage and minimum holding period required to apply such Gain Exclusion Percentage.
| Acquisition Date | Fixed Dollar Cap | Minimum Holding Period | Gain Exclusion Percentage |
|---|---|---|---|
| Aug. 11, 1993 to Feb. 17, 2009 | $10 million | More than five years | 50% |
| Feb. 18, 2009 to Sep. 27, 2010 | $10 million | More than five years | 75% |
| Sep. 28, 2010 to July 4, 2025 | $10 million | More than five years | 100% |
| After July 4, 2025 | $15 million (subject to inflation adjustments) | Three years | 50% |
| Four years | 75% | ||
| Five years | 100% |
QSBS requirements
There are several requirements that must be satisfied for the QSBS gain exclusion to apply.
At a high level, these include:
- The company issuing the stock must be classified as a domestic C corporation for tax purposes (and not be a C corporation that is subject to certain special tax rules, such as domestic international sales corporations, real estate investment trusts, real estate mortgage investment conduits, regulated investment companies and cooperatives).
- The stock must be received upon original issuance after August 10, 1993, and in exchange for cash, services (other than underwriter services) or property (other than stock). Limited exceptions to this original issuance requirement can apply in the case of stock acquired through testamentary transfers, gifts, partnership distributions and certain types of restructuring/reorganization transactions.
- During substantially all of the selling shareholder’s holding period, at least 80% (by value) of the corporation’s assets must be used in one or more qualified businesses.
- The shareholder must have held the stock for the minimum required holding period.
- At all times during the period from August 10, 1993, until immediately after the issuance of the stock, the “aggregate gross assets” of the corporation cannot have exceeded (i) in the case of stock issued prior to July 5, 2025, $50 million or (ii) in the case of stock issued after July 4, 2025, $75 million (subject to inflation adjustments).
- The corporation does not make certain disqualifying purchases of its own stock.
Planning for QSBS treatment
Obtaining QSBS tax benefits can involve numerous nuanced issues that may arise throughout the life cycle of a company.
As a result, business owners who intend to obtain QSBS tax benefits should take QSBS considerations into account both at the time of business formation and whenever any significant business events (e.g., restructurings, acquisitions, changes in business or in capital structure, etc.) are contemplated.
Furthermore, since QSBS benefits are available only for businesses held within a C corporation, business owners considering QSBS structures should separately evaluate whether a C corporation is a good fit for their business model.
To discuss potential QSBS tax benefits for your business, please contact Aaron Pinegar.
The opinions expressed are those of the author and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for informational purposes only and does not constitute legal advice. For more information, please contact a member of the Qualified Small Business Stock (QSBS) Tax Planning practice.
