Avoid Capital Gains Tax with Qualified Small Business Stock (IRC 1202)

I hadn't seen anything on this in other posts and thought I'd pass it along as it seems particularly applicable to this community and something y'all should know about. Also because I'm something of an "accidental" searcher due in large part to IRC 1202.

Caveat - go talk to your own lawyer and accountant before you rely on any of this. I've practicing law for over 20 years but I'm not YOUR lawyer (and I've never been a tax lawyer).

Under IRC 1202, funds that are invested in "qualified small business stock" (or QSB) are entitled to 100% capital gains tax exclusion once held for 5 years. This includes the value of stock granted as part of a management buy out or other grant - and in that case the resulting sale of the stock would be entirely free of capital gains tax. This could also be done through a restructuring, deleveraging or other liquidity event that could also result in an owner retaining control, etc. so you don't have to leave the business to get the benefit, which would effectively be the creation of a warchest of cash equivalent to what you would have paid in capital gains. Under IRC 1045, stock held for less than 5 years can be tacked together with successive QSB holdings to get to the 5 year mark. If in any way possibly, you should look to structure every investment or acquisition you're looking at to take advantage of this.

Here's a quick breakdown of what qualifies as QSB, but check out the statute for specifics and nuance. In general, if the below criteria are met, you should be able to find a way to make it work:

1. The Target is a domestic C corporation (also, the target can change the entity type as part of the transaction or you may be able form a C Corp to acquire the target, etc.).
2. The Target actively engages in business activities that are not specifically excluded in the statute. Exclusions include performance of certain professional services (accounting, investing, legal, etc.) and operating restaurants or hotels. Go look at the list.
3. The Target’s gross assets are less than, and have never been more than, $50m. This is calculated by adding (1) cash, (2) depreciated value of assets and (3) the invested capital. Note that this is not enterprise value, but asset value.
4. Purchaser/investor will need to receive stock issued directly from the company (ie. not purchasing from existing shareholders). This needs to be an original issuance and there are restrictions if the company has redeemed stock prior to the issuance (again, go look at the statute if that could be the case in your situation).