Section 1202 and Qualified Small Business Stock
For tech startups, attracting investment is crucial for funding research and development. As companies seek new investors and funding opportunities, the choice of business entity becomes increasingly important. Opting to incorporate as a traditional C corporation can offer significant long-term tax benefits for holders of Qualified Small Business Stock (QSBS). This is outlined in Section 1202 of the Internal Revenue Code.
What is Section 1202 and QSBS?
Section 1202 provides substantial tax benefits for the sale of QSBS. If certain criteria are met, up to 100% of gains could be excluded from taxable income. This can effectively eliminate double taxation, which is normally a disadvantage of a traditional corporation structure.
Requirements for QSBS
To take advantage of these benefits, the stock must meet several requirements:
- Held in a C Corporation: The stock must be issued by a C corporation.
- Qualified Trade or Business: The corporation must be an active “qualified trade or business” as defined in Section 1202.
- Asset Limits: At the time of stock issuance, and immediately after, the corporation’s gross assets must be under $50 million.
- Original Holder: The stock must be acquired at its original issue.
- Holding Period: The stock must be held for at least five years.
Each of these requirements has specific details that need careful consideration in determining whether stock qualifies as QSBS. Ensuring compliance can be complex but worthwhile, given the potential tax savings.
