As a business owner, it’s only natural to wonder what deductions are available for your business. And in your search, you’ll find there are countless deductions.
Here at Consolidated Planning, our decades-long journey in financial planning helps you plan, not guess, when it comes to maximizing all that’s important to you. Deductions included.
In this article, we’ll explain Section 1202 and the specific requirements to meet this deduction in order to ensure you take advantage of this deduction or find other deductions right for your business.
What Is Section 1202?
Section 1202 of The Internal Revenue Code (IRC), or Qualified Small Business Stock (QSBS), is not just another rule. At least not for business owners who qualify for it. According to the IRC, Section 1202 allows for small business owners to potentially exclude some percentage, up to 100% of the capital gains taxes that would otherwise be paid when selling a business.
Typically, if you sold your business for $10M, the federal capital gains tax owed is around 20-23% or $2.3M. OR you could pay $0 if this exclusion applies to you. $0.
Requirements To Qualify For Section 1202
So, at this point, if you’re not sure if you qualify – it’s time to find out. Here’s what the qualifications look like:
1. Business Ownership For More Than 5 Years
This deduction was designed to reward those who started their business YEARS ago and put in decades of hard work. Generally, the holding period of the stock begins on the date the stock was issued.
2. Eligible Shareholder
The stock must be held, directly or indirectly, by an eligible shareholder. Eligible shareholders are all non-corporate shareholders including individuals, trusts, and estates.
3. Original Issuance Of The Stock
More often than not, this factor is what most often disqualifies business owners. You must have acquired the first block of stock – not purchased from another shareholder.
4. Eligible C-Corporation
C-Corporations pay corporate level income taxes, and from there, take money out as a bonus. Which you then pay taxes on again. Because of this, many businesses tend to be S-Corporations. Additionally, you could be an LLC that elects to be taxed as a C-Corp to qualify.
5. $50M In Gross Assets Limitation
This limitation was put in place to actually reward small business owners. The company must not have had more than $50 million of tax basis in its assets at any time between Aug. 11, 1993, through the moment immediately after the issuance of the stock.
6. Redemption Transactions
Since the goal of this deduction is to reward people who invest in small businesses, Congress ensured certain rules were in place to block potential loopholes. Redemption transactions – the shuffling or stock between shareholders – may be a threat to your qualification.
7. Qualified Trade or Qualified Business
The business must be a qualified trade or business. While this is a rather vague qualification, it’s clear that personal services companies cannot qualify. This list may include: CPA firms, Financial Firms, Architecture, Engineering, Farming, Oil, Gas, Mining, and Hospitality. That’s because the principal asset is the trade, reputation, or skill of four or more employees.
8. Active Business Requirement
Your business has to be actively operating — not just holding investments or sitting on a pile of cash. The rule is this: at least 80% of the company’s assets, based on fair market value, need to be tied to actually running a qualified business. And this needs to be true for most of the time you own the stock.
Find Deductions To Reduce Taxable Income For Your Business
While the requirements needed to meet Section 1202/QSBS are incredibly specific, for the business owner who does in fact qualify – the benefits are vast.
However, for the vast majority of business owners who don’t qualify, there are other opportunities to defer or eliminate taxes for your business.
To understand what options might be right to reduce your taxable income, regardless if you’re ready to sell your business, talk with a business planning advisor at Consolidated Planning.
Exp. 6/2027
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Material discussed is meant for general informational purposes only and is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon only when coordinated with individual professional advice.
This material contains the current opinions of Neal Brincefield and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
Registered Representative and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 6115 PARK SOUTH DRIVE, SUITE 200, CHARLOTTE NC, 28210, 704-5528507. Securities products and advisory services offered through PAS, member FINRA, SIPC. Financial Representative of The Guardian Life Insurance Company of America® (Guardian), New York, NY. PAS is a wholly owned subsidiary of Guardian. Consolidated Planning, Inc. is not an affiliate or subsidiary of PAS or Guardian.
