Tax-Free Investment Gains

For more than 20 years, Section 1202 of the tax code has offered benefits to investors in certain small companies. Generally, non-corporate investors can use this tax break if they buy stock in companies that met specified criteria. After a holding period of at least five years, any gain on a sale will be taxed favorably.

Originally, the tax exclusion applied to 50 percent of the gain. In 2010, the exclusion was temporarily increased to 100 percent, for purchases after September 27 of that year; the 100 percent exclusion was extended but expired after 2014. Now the 100 percent exclusion on the sale of qualified small business stock (QSBS) is permanent. Another temporary measure—exclusion of QSBS gain from the alternative minimum tax—also is permanent under the Protecting Americans from Tax Hikes Act.

With the recent increase in capital gains tax rates for high-income taxpayers and the possible imposition of the 3.8 percent Medicare surtax, tax-free gains from a profitable investment may be appealing.

Trusted advice: qualified small business stock

Several requirements apply to the 100 percent tax exclusion on gains from selling small business stock. They include the following:

  • You must acquire stock in a C corporation, originally issued after Sept 27, 2010
  • The corporation must have total gross assets of $50 million or less at all times after August 9, 1993, & before it issued the stock
  • The company’s gross assets immediately after it issued the stock must have been no more than $50 million
  • During substantially all the time you hold the stock, the corporation meets the active business requirements (that is, the corporation is an eligible corporation that uses at least 80 percent (by value) of its assets in the active conduct of one or more qualified trades or businesses)
  • With some specified exceptions, you must have acquired the stock at its original issue, directly or through an underwriter

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