Small Business Stock

50% Exclusion of Gain from Sale of Small Business Stock [§1202]: An individual may exclude 50% of the gain from sale of qualified small business stock. The stock must have been issued after August 10, 1993, and held more than five years. The small business stock exclusion may not exceed ten times the taxpayer’s basis in the stock or $10 million, whichever is greater. The limits on the amount of small business stock exclusion apply on a per-issuer basis.

Alternative Minimum Tax (AMT): 42% of the excluded small business stock gain must be added to income for purposes of computing AMT.

Reduced Advantage: The Revenue Reconciliation Act of 1993 implemented §1202 with the intent of providing tax incentives for individuals to invest in small business. However, in recent years, regular capital gain tax rates have been lowered while maximum rates for §1202 stock remain at 28%. With lower rates on regular capital gains and possible AMT liability, benefits of the §1202 exclusion may be significantly reduced. 

Rollover of Gain from Sale of Small Business Stock [§1045]: An election is available for tax-deferred rollover of gain from the sale of qualified small business stock. The taxpayer must purchase new qualified small business stock within 60 days to qualify for the election. The entire gain is deferred if the new small business stock costs at least as much as the amount realized from the sale of the old small business stock. If the new small business stock costs less than the amount realized, the difference is taxable up to the amount of gain. Basis of new small business stock is reduced by the amount of gain deferred. 
Holding Period: The new

C Corporation: The small business stock must be issued by a C corporation with total gross assets of $50 million or less at all times after August 9, 1993, and before it issued the small business stock. The corporation’s gross assets immediately after it issued the small business stock must also be $50 million or less.

The corporation cannot be a:

1) DISC or former DISC,
2) Regulated investment company (RIC),
3) Real estate investment trust (REIT),
4) Real estate mortgage investment conduit (REMIC),
5) Cooperative, or
6) Corporation electing the Puerto Rico and possessions tax credit or having a direct or indirect subsidiary so electing.

Original issue stock: The small business stock must be acquired by the taxpayer at its original issue in exchange for money, property other than stock, or as compensation for services. Note: The small business stock will not qualify if the corporation redeemed stock from the taxpayer or a related person during a 4-year period beginning 2 years before the issuing date. Further, the small business stock will not qualify if the corporation redeemed more than 5% by value of its stock during a 2-year period beginning one year before the issuing date.

Active Business Requirement: During the taxpayer’s holding period, the corporation must use at least 80% of its assets by value in the active conduct of one or more qualified trades or businesses.

1) 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 other trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees,
2) Banking, insurance, financing, leasing, investing, or similar business, 
3) Farming business, including raising or harvesting trees,
4) Business extracting or producing natural resources eligible for percentage depletion, or
5) Business operating hotels, motels, restaurants, or similar business.

For purposes of the active business requirement, if the corporation owns more than 50% of another corporation, a pro rata share of that corporation’s assets are included in the 80% test above. A corporation will not meet the active business requirement if 10% of its assets’ total value consists of real estate that is not used in the active conduct of a qualified trade or business.