Section 1202, also called the Small Business Stock Gains exclusion, allows for capital gains from select small business stock to be excluded from federal taxes. The exclusion only applies to qualified small business stock acquired after September 27, 2010, and held for five or more years. A limitation of $10 million or 10 times the adjusted basis of the stock. If the limitation is exceeded, the taxable portion of the gain has a tax assessment of 28%. This tax break, made permanent by the Obama administration, is used as an incentive for non-corporate taxpayers to invest in small businesses. Not all small business stocks are qualified for tax breaks under Section 1202. The Code defines a small business stock as qualified if:
· It was issued by a domestic C-Corporation other than a hotel, restaurant, financial institution, real estate company, farm, mining companies, or any business relating to law, engineering, or architecture.
· Originally issued after August 10, 1993, in exchange for money, property not including stocks, or as compensation for services rendered.
· Business has $50 million or less in assets on the date the stock was issued and immediately after.
· The use of at least 80% of the corporation’s assets is for conducting one or more qualified active businesses.
· The issuing corporation does not purchase any of the stock from the taxpayer during the four-year period which begins two years before the issue date.
State taxes that conform to federal tax will also exclude capital gains of small business stock. Since not all states correlate with federal tax directives, it is important for taxpayers to seek guidance from their accountants on how their states treat realized profits from the sale of qualified business stocks.