Find Out If You Qualify for This Capital Gains Exclusion
If you have Qualified Small Business Stock (QSBS) and were a founder, early employee, or early investor at a startup or small business, you could potentially be eligible for a little-known, but major tax benefit when selling your stock. The Section 1202 exclusion, allows you to exclude up to $10 million dollars or 10 times your basis, whichever is greater, in gains when selling your stock. This exclusion is not for all businesses, however, if you meet the criteria to take advantage of the exclusion, this can be a way to save you potentially millions in taxes.
Am I eligible for the Section 1202 Exclusion?
There are several key boxes you need to check off to know if you and your business qualify for the capital gains exclusion. The 5 big ones are:
- Business must be a C-corp
- Business must have less than $50 million in gross assets
- Stock must be held for at least 5 years
- Must be an eligible business (generally professional service corporations, real estate, and financial businesses are examples of some of the businesses excluded).
- Stock must be originally issued
One of the most common concerns we hear from clients is how to reduce taxes. Maybe you had a great year at work and made a lot more than you anticipated...
Businesses that are eligible include technology companies, manufacturing businesses, and biotech. If the company is producing some sort of product, then it generally should be eligible.
How Much Gain Is Excluded?
Depending on when the stock was issued, you may be eligible for a full exclusion of capital gain on the sale.
| Date Stock was Issued | 1202 Exclusion Amount |
| 08/11/1993 – 02/18/2009 | 50% |
| After 02/18/2009 | 75% |
| After 09/27/2010 | 100% |
Other Requirements for the Capital Gains Exclusion
Although we covered at a high level how to qualify for the capital gains exclusion, there is a laundry list of other requirements and actions that you could take that could make your QSBS ineligible. Your financial planner and CPA can partner together to help you determine if the equity you have in your business qualifies you for the exclusion.
Why It Matters Now
We are in a historically low tax environment, relative to other periods in U.S. history. Most political and tax analyses agree that taxes are more likely to move up than they are further down. With potential changes to the tax code, also come potential changes to Section 1202 exemption. There has been a discussion in congress to modify the capital gains exclusion for high-income individuals. In addition to this, using this exclusion coupled with other estate planning mitigation strategies, could help individuals subject to estate tax, strategically break up their estate while preserving the capital gains exclusion and taking advantage of current life exemption amounts.
What Should YOU do?
The first step in understanding if strategies like taking advantage of the Section 1202 exclusion are applicable to you and your financial situation is starting off with a financial plan. A truly comprehensive financial planner will be able to diagnose your situation and see if there are any advanced tax strategies or estate planning techniques we could deploy in partnership with your CPA/attorneys. Financial planning is more than just “budgeting” or a “retirement analysis”. If you are looking for truly comprehensive planning, please reach out or schedule a call with MDRN Wealth.
