Section 1202 - Sell your business tax free
Sell your business the right way
Section 1202 is one of the most favorable, yet underutilized sections of the tax code. If used correctly, there is the potential to exclude 100% of the gain from the sale of a qualifying business; however, most CPA’s and tax preparer’s are not knowledgeable or trained in this area, letting their clients potentially pay millions of dollars more in capital gains tax upon the sale of a business than they need too.
Code Section 1202 was enacted in 1993 and allowed certain businesses to exclude some or all of the gain on the sale of qualified small business stock (QSBS). To utilize this niche yet powerful section of the tax code, certain criteria must be met:
The stock must have been original issue stock, and must have been issued by a C Corporation after August 10, 1993. It must also have been issued for money, or other non stock-property, or have been issued as compensation for services for anyone other than an underwriter of the stock.
The owner of the stock must be an eligible shareholder either directly or indirectly. This includes individuals, trusts and estates.
The stock must be held at least five years from the issuance date before being sold.
The tax basis in the Corporations assets must not exceed $50 million at any time between August 10, 1993 and the date the stock is issued. Note that this test is applied each time new stock is issued.
The Corporation must have used at least 80% of its assets in an active trade or business.
If there are significant redemptions of the stock in the year before or after a stock issuance (5% or more of the total stock issued), the the sale will be disqualified from the exclusion. For related parties, the testing period is extended to two years, and the significant threshold is reduced to 2%.
The business must be engaged in a qualified trade. This includes all activities other than personal services, financial services, farming, oil, gas and mining, hospitality, and real estate.
If the qualifications are met, the gain that is excluded would be the greater of $10 million, or the taxpayer’s basis in the stock multiplied by ten. The exclusion rate is 50% if the stock was acquired between August 11, 1993 and February 17, 2009; 75% if the stock was acquired between February 18, 2009 and September 27, 2010; or 100% if the stock was acquired between September 28, 2010 and the present date (currently there is no expiration date attached to this part of the code).
This is a very complex and strict section of the tax code. Please contact me if you would like to learn more about how you set your company up to make the most of this elusive section of the tax code.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.