An often-overlooked section of the Internal Revenue Code (IRC)—the Small Business Stock Gains Exclusion (IRC Sec. 1202)—can afford huge benefits for qualifying non-corporate taxpayers. The exclusion allows for a portion, and in some situations all, of the gain from the sale of qualified stock to be excluded from a taxpayer’s gross income for federal tax purposes, and potentially even from net investment income.
First, it must be determined whether stock that has been sold qualifies as small business corporation stock. A domestic C corporation will qualify if the aggregate gross assets did not exceed $50 million at any point after August 9, 1993, and prior to issuance. Further, the stock must be originally issued from the corporation and be acquired by the taxpayer in exchange for money, property, or services. In other words, the stock could not have been acquired from another shareholder. Finally, at least 80% of the corporation’s assets were used in the active conduct of a trade or business, and no more than 10% of the corporation’s assets consisted of either stock or real estate. Specifically excluded from the definition of a trade or business are businesses involving the performance of services in fields such as healthcare, consulting, and other businesses in which the principal asset is the reputation or skill of one or more employees.
The gain exclusion is tiered based on the date the stock was acquired. The stock must have been held for at least five years prior to sell and issued after August 10, 1993.
- For qualified small business stock purchased after September 27, 2010, the gain exclusion is 100%.
- For qualified small business stock purchased between February 18, 2009, and September 27, 2010, the gain exclusion is 75%.
- For qualified small business stock purchased before February 18, 2009, the gain exclusion is 50%.
These exclusions can mean huge savings for small business owners who have sold their original issue stock. Unfortunately, there is a limitation on the gain that can be considered for the exclusion of $10 million or 10 times the taxpayer’s basis in the stock.
If you have recently sold stock in a small business that potentially meets the qualifications outlined above, we recommend speaking with your tax advisor in order to determine if your gains are eligible for exclusion. For assistance with evaluating your eligibility, or with any matter related to small business tax advisory or business management, contact a PYA executive below at (800) 270-9629.