Making decisions in where and how to invest your money is critical for prospective investors. Thankfully, the IRS has several rules designed to incentivize investment in small businesses. Knowing the rules can help you in your portfolio planning; what to buy and when to sell. We’ll discuss three major provisions here: Section 1202, Section 1045, and Section 1244.

IRC 1202 – Exclusion for gain from Qualified Small Business Stock

With the implementation of IRC 1202, the federal government incentivized investment in small & start-up businesses with a provision to exclude gains from the disposition of Qualified Small Business Stock.

IRC section 1202 provides for the exclusion of 100% of any gain on the disposition of qualified small business stock that has been held for 5 years, provided it is stock that was acquired after the enactment of the “Creating Small Business Jobs Act” of 2010.

In this context, Qualified Small Business Stock is defined as:

Stock from a corporation deemed a Qualified Small Business at issuance, acquired by the taxpayer at original issue, in exchange for money, property, or as compensation for services. Additionally, the Corporation generally must meet Active Business requirements for substantially all of the Taxpayer’s holding period.

A Qualified Small Business is defined as any domestic C corp whose aggregate gross assets after enactment of the Revenue Reconciliation Act of 1993 & before issuance did not exceed $50,000,000, and did not exceed that limit immediately after issuance of the stock.

The exclusion may not exceed the greater of:

1. $10,000,000 less gain from this corporation’s stock excluded in prior years
2. 10 times the total adjusted basis of qualified stock issued by the corp. & disposed of by the taxpayer during the year.

IRC 1045 – Rollover of Gain from Disposition of Qualified Small Business Stock

To promote continued investment in small business, the Internal Revenue Code allows for Taxpayers to defer the gain on disposition of Qualified Small Business Stock by using the proceeds to invest in another Qualified Small Business’s stock.

Under IRC section 1045, gain from the sale of Qualified Small Business Stock will be deferred by the amount of gain that is invested into another Qualified Small Business Stock within 60 days after the sale. The Taxpayer will only recognize gain in excess of the cost of the new stock purchased. The Taxpayer’s basis in the newly acquired stock is reduced by the amount of gain not recognized on disposition of the original stock.

IRC 1244 – Losses on Small Business Stock

To reduce the risk associated with investing in small business, IRC 1244 allows the Taxpayer to treat a loss from disposition of Qualified Small Business Stock as an ordinary loss, avoiding the limitations on deducting Capital losses.

IRC section 1244 allows for the treatment of losses on section 1244 stock that would otherwise be treated as capital losses as ordinary losses. For a single taxpayer, no more than $50,000 may be treated as an ordinary loss in a given tax year.

For purposes of this allowance, Section 1244 Stock is defined as:

Stock that is from a corporation that was a Small Business Corporation, or a corporation capitalized with $1,000,000 or less of money and property, and was issued by the corporation for money or property (excluding other stock and securities), and from a corporation that has derived more than 50% of its aggregate gross receipts in the preceding 5 years from sources other than royalties, rents, dividends, interests, annuities, or gains from the sales or exchanges of stocks or securities.

MRPR Can Help

As a full-service accounting and business advisory firm, we offer a number of services that aid in the understanding and compliance for small business and start-up tax and the treatment of small business tax incentives to investors.