Section 1202 of the Internal Revenue Code (IRC) allows the selling owner of a business to exclude up to $10 million of gains from income/capital gains tax.
What’s the catch?
No catch, but there are a few rules. The law became permanent at the end of 2015 and asserts that sellers may exclude from taxable income a portion of the gain realized on the sale of their “qualified small business stock.” Also, the seller must hold the stock for more than five years.
This exclusion is limited, on a “per issuer” basis to the greater of $10 million or ten times the basis in the stock. You must, however, add back part of the excluded gain as a preference for alternative minimum tax purposes.
“Qualified small business stock,” means any stock in a domestic (US) corporation if:
- The corporation is a “qualified small business” at the time of stock issuance; and
- You acquired the stock after September 27, 2010 at its original issue in exchange for money, other property (not including stock), or as compensation for services provided to the corporation, so called “Sweat Equity.”
A “qualified small business” is a domestic C corporation with up to $50 million in gross assets at all times before the stock issuance. The corporation must be an “active business” rather than simply an investment company. For example, dealing in or rental of real property is not considered the active conduct of a qualified trade or business.
Founders take note
Various restrictions, limitations and technical rules apply but this new tax provision can be a boon to new companies as well as old companies that issue additional stock after September 27, 2010.
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