7521 / What is qualified small business stock?

IRC Section 1202 provides for special treatment of qualified small business stock, which generally means stock (a) in a C corporation that is a “qualified small business; (b) that meets the active business requirement (explained below); (c) that was originally issued after August 10, 1993; and (d) (except as otherwise provided) was acquired by the taxpayer at its original issue in exchange for money or other property (not including stock), or as compensation for services to the corporation.¹ For the tax treatment of qualified small business stock, see Q 7522.

An issuing corporation is a qualified small business if it is a domestic corporation with aggregate gross assets of $50,000,000 or less at all times after August 10, 1993. Generally, “aggregate gross assets” means the amount of cash and the aggregate adjusted bases of other property held by the corporation. Under certain circumstances, a parent corporation and its subsidiary corporations may be treated as one corporation for purposes of determining a corporation’s aggregate gross assets.²

As a general rule, stock acquired by the taxpayer will not be treated as “qualified small business stock” if the issuing corporation has directly or indirectly purchased any of its stock from the taxpayer (or a related person) within two years before or after the date of issuance.³ But an issuing corporation may redeem de minimis amounts of stock without the loss of qualified small business stock treatment. Stock redeemed from a taxpayer (or related person) exceeds a de minimis amount of stock only if the aggregate amount paid for the stock exceeds $10,000 and more than 2 percent of the stock held by the taxpayer and related persons is acquired.⁴

Similarly, stock issued by a corporation will generally not be treated as qualified small business stock if the issuing corporation makes a significant redemption of stock or, in other words, redeems stock with an aggregate value of more than 5 percent of the value of all of its stock within one year before or after the date of issuance.⁵ But an issuing corporation may redeem de minimis amounts of stock without the loss of qualified small business stock treatment. Stock redeemed by an issuing corporation exceeds a de minimis amount only if the aggregate amount paid exceeds $10,000 and more than 2 percent of all outstanding stock is purchased.⁶