Are you a business owner looking for a way to save on taxes? The Section 1202 Exclusion is a great option for businesses that qualify. In this article, we will discuss which types of businesses qualify for this exclusion and how it can help you save on taxes.
The Section 1202 Exclusion is a provision of the Internal Revenue Code that allows certain businesses to exclude up to 100% of their capital gains from taxation. This exclusion applies to the sale or exchange of qualified small business stock (QSBS) held for more than five years. The exclusion applies to both long-term and short-term capital gains, meaning that you can receive up to 100% of your gains tax-free.
To qualify for this exclusion, the business must meet certain criteria. The business must be a C corporation, and it must have total assets of $50 million or less. Additionally, the business must have gross receipts of $50 million or less and must have been in operation for at least five years.
In addition to meeting the criteria, the business must also have certain types of stock. These include common stock, preferred stock, and restricted stock. The stock must be issued by the business and must have been held by the taxpayer for more than five years.
If your business meets these criteria, you may be eligible to take advantage of the Section 1202 Exclusion and save on taxes. This exclusion can be an invaluable tool for businesses that qualify, allowing them to keep more of their profits and invest in their future.
At Creative Advising, we specialize in helping businesses take advantage of tax savings opportunities like the Section 1202 Exclusion. Contact us today to learn more about how we can help you maximize your tax savings.
Qualifying Businesses
Section 1202 of the US Internal Revenue Code allows for investors to enjoy a reduced rate of capital gains taxes on certain stock investments. The benefits are available to entrepreneurs and small businesses that qualify for the Section 1202 Exclusion. Qualifying businesses must be C corporations that are organized in the US and meet the standard small business definition. They must also have gross assets worth no more than $50 million when the stock was initially issued and certain other requirements.
Qualifying businesses must be engaged in the active conduct of certain approved trade or business activities, such as the development, production, or distribution of certain types of property. Businesses whose main purpose is to hold intellectual property, such as patents, trademarks, or copyrights, are also eligible for the Section 1202 Exclusion.
The type of stock that qualifies for the Section 1202 Exclusion can also vary. Generally, only stock issued domestically and to the general public after August 10, 1993 qualifies. Additionally, the stock must have been issued for money, property, or other services provided to the corporation, and not taken in exchange for another security, to qualify.
These qualifications provide entrepreneurs and small businesses with the opportunity to realize significant tax savings on the sale of certain stock they issue. By planning ahead and taking advantage of the Section 1202 Exclusion, businesses can reap the rewards of favorable tax treatment for their investments.
Qualifying Stock: What types of stock are eligible for the Section 1202 Exclusion?
At Creative Advising, we encourage our clients to take advantage of tax strategies available to them. The Section 1202 Exclusion of the Internal Revenue Code is one of the most lucrative opportunities for those with qualifying stock. U.S. taxpayers who hold and sell qualified small business stock (QSBS) during 2020 are eligible for 100% of gains tax-free, excluding the 20% minimum holding period.
The Section 1202 Exclusion applies to businesses organized as C-corporations, and can be used by individuals, trusts, or estates that own the corporation’s stock. The stock must be issued after August 10, 1993 and must have been acquired at its original issue (in a tax-free exchange) from an unrelated C-corporation. In order for the stock to qualify as QSBS, the corporation must be a domestic C-corporation, actively engaged in a qualified trade or business and must meet certain requirements regarding the size of the company’s aggregate assets.
Any business that meets these requirements, including certain lending companies, consulting businesses, medical service companies, engineering firms, and software businesses, can qualifiy for the Section 1202 exclusion. To ensure that this incredibly valuable tax strategy is properly and fully utilized, it is always beneficial to consult with a tax advisor like those at Creative Advising.
Gains Exclusion: What percentage of gain from the sale of qualifying stock is eligible for the Section 1202 Exclusion?
At Creative Advising, we are often consulted to assist in the choice of entity structure to obtain the highest level of tax efficiency. Section 1202 of the Internal Revenue Service Code provides for an exclusion from gross income of gain on the sale of qualified small business stock acquired at its original issue. This exclusion was recently expanded as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act.
Under the Section 1202 Exclusion, up to 100% of the gains from the sale or exchange of qualifying stock may be excluded from ordinary income. This attractive source of tax savings is why we frequently recommend that eligible small business owners look into this as a potential option.
Which types of businesses qualify for the Section 1202 Exclusion? Eligible small business stock must have been originally issued after August 10, 1993 and have been acquired directly from the taxpayer at its original issue for money or other property or services, and the taxpayer must have held the stock for more than 5 years. The company must meet specific requirements, including that it be a domestic C corporation engaged in conducting an active for-profit business, with assets not exceeding $50 million and a maximum of 200 shareholders. Due to the complexity of these requirements, it’s best to work with a knowledgeable accountant, like one from our Creative Advising firm, to ensure that your business meets the eligibility requirements and receive the maximum benefit.
Holding Period Requirements
The Section 1202 Exclusion requires that any qualifying stock be held for a minimum of five years. During this holding period, the stock must remain in the taxpayer’s possession in order to qualify for the exclusion. This is so that the stock qualifies as a capital gain when the stock is eventually sold or exchanged. If the stock does not satisfy these holding period requirements, then the taxpayer will not be able to take advantage of the exclusion.
It’s important to note that the holding period begins on the date the taxpayer acquired the original stock, not the date that the stock was converted into a qualifying small business corporation. For example, if a taxpayer converts their stock into qualifying QSBC stock one year after they originally purchased it, the holding period still begins on the original purchase date.
The Section 1202 Exclusion is beneficial to individual taxpayers who have an ownership interest in a qualifying business. Specifically, qualifying businesses are predominantly C-corporations, although LLCs, S-corporations and general partnerships are also eligible. To qualify for the exclusion, the business must be a U.S.-based company that engages in eligible domestic business activities and has gross assets of less than $50 million prior to the issuance of the qualified stock. In addition, at least 80% of the company’s assets must consist of cash, real estate, inventory, tangible personal property used in the business, and other similar tangible assets.
Tax Benefits: What are the tax benefits associated with the Section 1202 Exclusion?
Tom Wheelwright on the Section 1202 Exclusion:
The Section 1202 Exclusion is a valuable tax incentive that provides tax benefits to small business owners. Under the provision, those who sell stock in a qualified small business may be able to exclude up to 100% of the gain realized on the sale from their federal income taxes. The exclusion is available for eligible stock acquired after August 10, 1993. Qualified small business stock must meet certain requirements to qualify for the exclusion.
The Section 1202 Exclusion enables business owners to keep more of the money that they have earned and invested in their businesses. This can be particularly beneficial for businesses whose gains haven’t been heavily taxed due to low income levels. Under the exclusion, the gain realized from the sale of the qualified small business stock is fully excluded from federal taxes. This means that business owners can keep more of their money, allowing them to reinvest in their business or use it to cover other expenses.
Which types of businesses qualify for the Section 1202 Exclusion? In order to qualify, the stock must be issued by a domestic C-corporation. The company must use substantially all of its assets (at least 80%) in conducting an active business within the United States, and must have gross assets of no more than $50 million at the time the stock is issued. The company also must maintain active business operations for five years prior to the stock sale in order to qualify for the exclusion.
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