Qualified Small Business Stock (QSBS) Year-End Considerations

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By Dan Wright

Noncorporate investors who sold or plan to sell QSBS in 2011 and are expecting a large tax windfall under Section 1202
of the I.R.C. (“Section 1202”) will likely be disappointed. In general,
the tax break under Section 1202 for gain realized by a noncorporate
investor on the sale or exchange of QSBS in 2011, which is held by such
investor as a capital asset and for a period of over 5 years, is about
1%. So why are people making such a big deal about Section 1202 as this
year comes to a close?

Noncorporate investors who acquire QSBS after September 27, 2010, and
before January 1, 2012, hold the stock for over 5 years, and then sell
the stock at a gain will generally be able to exclude 100% of such gain
(up to a minimum of $10 million) for both regular tax and AMT purposes.
That’s right, potentially a 0% federal income tax! Of course, this
assumes all of the other tests in the fine print of the rules are
satisfied.

If you are looking for ways to take advantage of Section 1202 before year-end, here are some considerations:

1. If you have a business that is held as a sole proprietorship, a
   single-member LLC or a partnership, then you should consider
   incorporating the business by the end of the year. For the 100%
   exclusion under Section 1202 to apply, the business has to be held as a
   domestic “C” corporation when the QSBS is issued to the investor or
   founder and during substantially all of their holding period of the
   QSBS. If the business has always had less than $50 million in gross
   assets, the owners who receive original issue stock upon incorporation
   of the business can generally qualify for the 100% exclusion under
   Section 1202 (assuming all other tests are met). However, incorporating
   a business can have unexpected immediate and long-term tax and legal
   consequences, so be sure to get good advice before making the change.


2. If you are considering issuing stock options to key employees, board
   members, or service providers before the end of the year, think about
   using restricted stock instead. A stock option itself likely cannot
   qualify as QSBS, but stock received by exercising options likely can
   become QSBS on the


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