WHAT IS SECTION 1202?
In the United States, Section 1202 is known as the Small Business Stock Gains Exclusion. It is a section of the IRS code that allows capital gains from Qualified Small Business (QSB) stock to be exempt from federal taxes when selling. But not all small business stocks qualify:
The 1202 code was designed to serve as a rewarding incentive for non-corporate taxpayers to invest in small businesses. The amount of gain excluded is limited to an upper limit of $10 million, or 10 times the adjusted basis of the stock. It can offer significant savings and makes QSBs an attractive structure for business owners who plan to eventually sell.
THE PROPOSED REDUCTION IN PERCENTAGE GAIN EXCLUSION
In September of 2021, the U.S. House Ways and Means Committee issued draft legislation proposing to amend Section 1202 to remove the 75% and 100% gain exclusions for those whose adjusted gross income (AGI) is $400,000 or more, or for that which is a trust or estate. Stockholders would still qualify for the 50% gain exclusion that applies to QSBs issued before February 18, 2009. Section 1202 was originally introduced as a way to encourage investment in start-up companies. The new legislation is designed to “mitigate wealth inequality” by adding a surtax on the highest-income taxpayers. As it is currently written, the proposed legislation would be effective for sales and exchanges of QSBs happening on or after September 13, 2021.
HOW THIS CHANGE STACKS UP
Under the current Section 1202 code:
Under the proposed amended Section 1202:
The draft legislation includes other tax increases that could impact any potential gains from the sale of QSB stock. It would raise the highest long-term capital gains rate from 20% to 25% for gains recognized on or after September 13, 2021. Any capital gains recognized on or before September 13, 2021, or under a written binding contract in effect on or before September 13, 2021, is subject to the 20% tax rate.
The legislation also introduces a new high-income surcharge provision. It would place a 3% tax on modified AGI over $5 million (or over $2.5 million in the case of a married individual filing separately), and over $100,000 in the case of a trust or estate.
While the legislation has not yet been approved, business owners should weigh its impacts when considering investing in QSB stock, and be mindful when amending any contracts entered into before the retroactive dates under the provisions. Benchmark International is not a tax authority, and it is recommended that you speak with a qualified tax professional regarding how this legislation may impact you as a business owner.
Americas: Sam Smoot at +1 (813) 898 2350 / Smoot@BenchmarkIntl.com
Europe: Michael Lawrie at +44 (0) 161 359 4400 / Enquiries@BenchmarkIntl.com
Africa: Anthony McCardle at +27 21 300 2055 / McCardle@BenchmarkIntl.com
ABOUT BENCHMARK INTERNATIONAL
Benchmark International’s global offices provide business owners in the middle market and lower middle market with creative, value-maximizing solutions for growing and exiting their businesses. To date, Benchmark International has handled engagements in excess of $7B across various industries worldwide. With decades of global M&A experience, Benchmark International’s deal teams, working from 14 offices across the world, have assisted hundreds of owners with achieving their personal objectives and ensuring the continued growth of their businesses.
Website: http://www.benchmarkintl.com
Blog: http://blog.benchmarkcorporate.com