For many years, investors in qualified small business stock (QSBS) have sought to take advantage of a little-known tax election under Section 1202 of the Internal Revenue Code (IRC). Subject to certain eligibility requirements (outlined below), Section 1202 allows stockholders to claim an exclusion from the gain on the sale of QSBS for federal income tax purposes. The gain exclusion could be very significant depending on facts and circumstances. The realization of this benefit has become more likely with the passage of the Inflation Reduction Act because none of the proposed amendments, which were meant to curb Section 1202 benefits, were adopted.
The following are some of the essential eligibility requirements to qualify for Section 1202 gain exclusion:
- The QSBS must be held for more than five years.
- Only individual stockholders (not corporate) can qualify for the gain exclusion.
- QSBS must be sold (for federal income tax purposes) to take advantage of Section 1202’s gain exclusion.
- QSBS must not have had “aggregate gross assets” in excess of $50 million at any time prior to or immediately after the issuance of the stock.
The potential tax benefits to investors in QSBS are significant and available if the eligibility requirements are met. A successful sale of QSBS involves complex tax, valuation, and shareholder compliance issues. In the initial planning stages, completing a well-reasoned valuation by a qualified business valuation professional is a critical step in establishing the shareholder’s basis. The valuation professional should be accredited by the American Society of Appraisers (Accredited Senior Appraiser) and have industry experience in the QSBS company. Additionally, the appraiser should know all the appropriate methods and business valuation standards relevant to tax-related engagements.
If you are considering making a Section 1202 election and sale of QSBS in the future, we recommend you consult your tax, valuation, and M&A advisors early in the process to maximize benefits.
About Evergreen’s Business Valuation Practice:
Whether it’s a contentious litigation, a shareholder buyout, or an IRS audit, having a credible valuation expert is critical. Credibility comes from the combination of preparation, expertise, integrity, and consistency. For more than 20 years, Evergreen has helped clients navigate difficult valuation and transaction matters. Our staff of credentialed valuation professionals has a proven track record of developing and supporting well-reasoned opinions that withstand scrutiny.
Each valuation engagement presents a unique set of demands, which can be difficult to navigate. An in-depth knowledge of valuation standards, tax, case law, and GAAP (“Generally Accepted Accounting Principles”) is required to ensure appropriate methods and approaches are applied. Evergreen’s credentialed Business Valuation experts appreciate and understand these requirements and have extensive industry experience.
