Section 1202 of the Internal Revenue Code (IRC) provides an opportunity for eligible taxpayers to minimize their tax burden if specific requirements are met. Here’s a detailed breakdown to help you understand and maximize this valuable tax benefit.

What Is QSBS?

Qualified Small Business Stock refers to shares in a C Corporation that meet certain criteria. To qualify as QSBS:

1. Issuance Requirements:
   • The stock must be acquired at its original issue for cash, property (excluding other stock), or services provided to the corporation.
2. Qualified Small Business (QSB):
   • The issuing corporation’s gross assets cannot exceed $50 million at the time of issuance and immediately afterward.

Which Corporations Are Eligible?

Not all corporations can issue QSBS. The following are excluded:

• Domestic International Sales Corporations (DISC)
• Regulated Investment Companies (RIC)
• Real Estate Investment Trusts (REIT)
• Real Estate Mortgage Investment Conduits (REMIC)
• Cooperatives

Additionally, the corporation must use at least 80% of its assets in the active conduct of a qualified trade or business.

What Constitutes a Qualified Trade or Business?

A business qualifies if it is actively engaged in operations, excluding certain industries such as:

• Any trade or business where the main asset of such trade or business is the reputation or skill of 1 or more of its employees including businesses involving services in the fields of health, law, architecture accounting, etc.
• Any banking, insurance, financing, leasing, investing, or similar business
• Any farming business
• Any business involving the production or extraction of products for which a deduction is allowable under section §613 or §613A (mines, wells, and other natural deposits) and
• Any business of operating a hotel, motel, restaurant, or similar business.

Taxpayer Eligibility

To claim the QSBS exclusion, a taxpayer must:

• Be a non-corporate taxpayer.
• Hold the QSBS for at least five years.

Pass-Through Entities

If you own an interest in a pass-through entity (such as an LLC or partnership) that holds QSBS, you may still qualify for the exclusion if:

• The entity meets the five-year holding requirement.
• The gain is passed through to a non-corporate owner.
• You held an interest in the entity at the time of stock acquisition and throughout the holding period.

How Much Gain Can You Exclude?

The exclusion percentage depends on when the stock was acquired:

Acquisition Date	Exclusion Percentage
August 11, 1993 – February 17, 2009	50%
February 18, 2009 – September 27, 2010	75%
September 28, 2010 – Present	100%

Limits on Gain Exclusion:

• Annual Limit: You can exclude up to 10 times the adjusted basis of QSBS sold in a given year for each qualifying issuer of securities. You may exclude 10 times the adjusted basis from the stock sold from Corporation X and still exclude 10 times the adjusted basis from the stock sold from Corporation Y in the same year if all other requirements for the exclusion are met.
• Lifetime Limit: A lifetime exclusion cap of $10 million applies for each qualifying issuer of securities. You may exclude $10 million in gain from the sale of stock of Corporation X and still exclude $10 million in gain from the sale of stock of Corporation Y if all other requirements for the exclusion are met.

By: Cedar Bauer, Esq.