8683 / What are the requirements to exclude 50, 75 or 100 percent of the gain on the sale of qualified small business stock?

A domestic C corporation (not an S corporation) with aggregate gross assets that do not exceed $50 million between August 10, 1993 and the date the stock was issued (the aggregate gross assets also cannot exceed $50 million immediately after the stock was issued);³

Any trade or business other than one involving the performance of legal, health, engineering, architecture, accounting, actuarial services, or any other trade or business in which the principal asset is the skill or reputation of its employees; and

At least 80 percent of its assets by value must be used in the active conduct of a qualified trade or business.

The aggregate amount of eligible gain from the disposition of qualified small business stock issued by one corporation that may be taken into account in a tax year may not exceed the greater of the following amounts:

(a)  $10 million ($5 million in the case of married taxpayers filing separately) reduced by the aggregate amount of such gain taken into account in prior years; or

(b)  10 times the aggregate bases of qualified stock of the issuer disposed of during the tax year.

For purposes of the limitation in (b), above, the adjusted basis of any qualified stock will not include any additions to basis occurring after the stock was issued.⁴

Gain realized by a partner, shareholder, or other participant that is attributable to a disposition of qualified small business stock held by a pass-through entity (i.e., a partnership,
S corporation, regulated investment company, or common trust fund) is eligible for the exclusion if the entity held the stock for more than five years, and if the taxpayer held an interest in the pass-through entity at the time of acquisition and at all times since the acquisition of the stock.⁵

Significantly, a taxpayer is not entitled to the Section 1202 exclusion as well as the reduced capital gains rates (0 percent, 15 percent or 20 percent). Instead, the tax rate is subject to a maximum rate of 28 percent. Coupled with the 50 percent exclusion, the actual maximum effective rate on the gain is 14 percent.

Any gain excluded under IRC Section 1202 by a married couple filing jointly must be allocated equally between the spouses for purposes of claiming the exclusion in subsequent tax years.⁶

Special rules apply to IRC Section 1202 stock for alternative minimum tax purposes (see Q 8574 to Q 8579 for a discussion of the AMT). In the case of stock eligible for the 50 percent or 75 percent exclusion, an amount equal to 7 percent of the amount excluded from gross income for the taxable year under IRC Section 1202 will be treated as a preference item.⁷ If the stock is eligible for the 100 percent exclusion, no portion of the excluded gain will be treated as a preference item (this provision was made permanent by the PATH Act).