5 Things You Need to do to Qualify for the Section 1202 Exclusion
Qualified small business stock, or QSBS, is a type of security that offers certain tax benefits to the holder. If you hold QSBS for more than five years, you may be able to exclude some or all of the gain from taxation. To qualify for the section 1202 exclusion, there are a few things you need to do. Here are the five key points you need to remember:
- The stock must be issued by a qualified small business. In order to qualify, the business must meet certain criteria regarding its size, industry, and location.
- You must have acquired the stock at the original issue. This means that you cannot purchase QSBS on the secondary market.
- You must hold the stock for more than five years. 1202 exclusion is only available if you hold the stock for at least five years before selling it.
- You can only exclude a limited amount of gain from taxation. The 1202 exclusion is capped at the greater of $10 million or 10% of the adjusted basis of the QSBS.
- You must meet certain other requirements. In addition to the above criteria, you must also file a tax return in the year you sell the QSBS and attach a statement certifying that you meet all of the requirements for the exclusion.
If you meet all of the above criteria, you may be eligible to exclude some or all of the gain from taxation on your sale of QSBS. This can provide significant tax savings, so it’s important to be aware of the rules if you’re thinking about investing in QSBS.
The exclusion applies when the stock is sold, exchanged, or retired. It does not apply when the stock is gifted or transferred in a divorce settlement. Additionally, the exclusion only applies to stocks that are owned by the taxpayer for more than five years.
To qualify for the exclusion, the stock must be issued by a qualified small business. A qualified small business is one that meets all of the following criteria:
- The business must be a C corporation
- The business must be engaged in an active trade or business
- The stock cannot be publicly traded
- The gross assets of the business cannot exceed $50 million
If the stock meets all of the above criteria, then up to $10 million of gain from the sale of the stock can be excluded from taxation. This exclusion is per taxpayer, so if you are married and file a joint return, you can exclude up to $20 million of gain. Additionally, this exclusion applies to both long-term and short-term capital gains.
If you don’t meet the requirements for the Section 1202 exclusion, you will have to pay taxes on the gain from the sale of the stock. The amount of tax you will owe will depend on how long you owned the stock. If you owned the stock for less than a year, you will pay short-term capital gains tax, which is the same as your ordinary income tax rate. If you owned the stock for more than a year, you will pay long-term capital gains tax, which is currently 15% or 20%, depending on your income.
So, if you want to take advantage of the Section 1202 exclusion, make sure you understand the requirements and plan accordingly. With a little planning, you can save yourself a lot of money in taxes.