June 17, 2025 • 11 mins
What Is 1202 Stock?
Millions of dollars in potential tax savings are hiding in plain sight for many business owners. Section 1202 stock, also known as Qualified Small Business Stock (QSBS), represents one of the most powerful yet underutilized tax strategies available to entrepreneurs planning their exit.
Tax expert Phil Giguere breaks down this remarkable provision that allows eligible business owners to exclude up to 100% of capital gains when selling qualified small business stock. The numbers are staggering - on a $10 million business sale, QSBS status could save over $2 million in federal capital gains taxes alone, plus avoiding the additional 3.8% Net Investment Income Tax. When state tax benefits are factored in, the combined savings can approach or exceed $3.3 million.
Whether you're launching a new venture, considering converting an LLC to a C-Corporation, or mapping out your eventual exit strategy, this episode provides critical insights into potentially saving millions through proper tax planning.
To learn more about MP CPAs visit:
https://thempgroupcpa.com/
MP CPAs
413-739-1800
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:01):
Welcome to the Knowing what Counts podcast, the
place where expert guidancemeets smart financial decisions.
Whether you're a high net worthindividual or a thriving
business, the experts at MPCPAsare here to help you protect and
optimize your wealth.
Let's get started, becausesuccess begins with Knowing what
(00:22):
Counts.
Because success begins withknowing what counts.
Speaker 2 (00:31):
Could a little-known tax provision help you save big
on capital gains?
In this episode of Knowing whatCounts podcast, we explore
Section 1202, stock what it is,who qualifies and how it can
improve significant taxadvantages for business owners
and investors.
Don't miss this deep dive intoone of the most valuable tools
for entrepreneurs looking tomaximize their exit strategy.
(00:54):
Welcome back everyone.
I'm Sofia Yvette, co-host slashproducer, back in the studio
with Phil Giger, partner atMPCPAs.
So, phil, how's it going?
Speaker 3 (01:06):
I'm good.
How are you doing today, Sophia?
Speaker 2 (01:09):
I'm doing well, Phil.
Speaker 3 (01:10):
Great.
Speaker 2 (01:11):
So go ahead and introduce yourself to our
listeners today, Sure.
Speaker 3 (01:17):
So my name is Phil Jaguer.
I'm a partner here at MPCPAs.
I've been here since 2006.
We're a full-service firm, butI specialize mostly in high net
worth individuals with a focuson private equity.
I also work with a lot ofclosely held family businesses
and help advise them on theirtax strategies.
Speaker 2 (01:39):
So, Phil, what is QSBS and what does it aim to
accomplish?
Speaker 3 (01:45):
So QSBS is defined by Code Section 1202.
It is a very large topic.
We could probably do two hourson this, but I won't make anyone
do that.
It is a tax incentive for theowners of small businesses on
their exit, on their sale oftheir small businesses.
The owners of small businesseson their exit, on their sale of
(02:07):
their small businesses.
It was introduced in 1993 as anincentive for entrepreneurs and
investors to invest in thesetypes of small businesses.
Speaker 2 (02:15):
What are the key benefits for investors?
Speaker 3 (02:19):
So the key benefit for investors in these small
businesses is a tax benefit, soit's the greater of $10 million
or 10 times your basis in thestock when you sell.
If you had a $10 million gainon the sale of your business,
you'd be able to exclude all ofthat gain from your tax return
(02:40):
in the year you sell yourbusiness.
If you take that $10 millionand you multiply it by the
capital gains rate of 20%,that's a $2 million savings on
the sale of your business.
The other great thing aboutthis is that is not subject to
the net investment income tax,which is a 3.8% tax on
additional investment income.
All in all, you couldpotentially not pay tax of
(03:03):
$2,380,000 on a $10 million saleof your business.
The other side of that is alsothat it's 10 times your basis,
so it's the greater of.
If you had a taxpayer whoinvested $2 million into the
business to start, then theirpotential 1202 exclusion is 10
times that 20 million, so theycould sell their business for 20
(03:25):
million and still also pay notax on that sale.
So it's a really great planningopportunity for small
businesses.
The other great thing is thatit's a per shareholder exclusion
and so let's just say you had10 equal shareholders of a
business and they sold theirbusiness for $100 million.
(03:45):
They would each get the $10million exclusion and the entire
sale would have no tax.
So it's really a pretty cooltax planning strategy.
Speaker 2 (03:55):
Wow, my goodness, it certainly does sound like it has
some nice benefits.
What has made 1202 so popular?
Nice benefits.
What has made 1202 so popular.
Speaker 3 (04:05):
So to talk about that , we kind of have to go back a
little bit and say why wasn't itpopular, since it's been around
since 1993?
When it first came into beingin 1993, it was not 100%
exclusion, it was only a 50%exclusion.
So on your $10 million gain,you would only be able to
exclude $5 million.
There was also some AMT adbacks.
(04:26):
Not everyone really thought itwas worth all the effort to do
this 1202 stock.
That all changed in 2010 whenCongress changed the exclusion
to 100% and they also removedthe AMT ad back.
So we started seeing more andmore of it after that ad back.
So we started seeing more andmore of it after that and then
(04:46):
in 2013, when the net investmenttax came into play another
reason why you would want to dothis because you can avoid that
3.8% additional tax.
But then the big changehappened in 2017 with the Tax
Cuts and Jobs Act, tcja.
That was the big change becauseit lowered the corporate income
tax rate down from the highestof 35% down to 21%.
(05:08):
It made being a C-Corp andrunning the business as a C-Corp
and operating as a C-Corp muchmore palatable to the
shareholders to not have to payat that high tax rate of 35%.
Tax rate of 35%.
So now we see more and morebusinesses starting up as
C-Corps to take advantage of the1202 because they know they can
(05:29):
have that nice low corporatetax rate.
Speaker 2 (05:31):
So, phil, what are the key requirements to qualify
as QSBS?
Speaker 3 (05:36):
In order to have qualified small business stock,
your business first has to beconsidered a qualifying small
business.
The Internal Revenue Code laysfour hurdles that you have to
get past to be considered aqualified small business.
The first is that you have tobe a domestic C-Corp.
So no foreign corporations, nopartnerships, no S corporations.
You have to be a regular old USC-Corp.
(05:59):
The second test is that youhave to pass the gross assets
test, and so that is both beforeand immediately after you
become a C corp.
The gross assets of thebusiness have to be $50 million
or less.
So these are supposed to be forsmall businesses, so they want
to make sure that you'reconsidered a small business $50
(06:20):
million or less.
The third hurdle is that 80% ofthe assets of the business must
be used in the trade orbusiness.
So third hurdle is that 80% ofthe assets of the business must
be used in the trade or business, so you can't have a bunch of
investments or things like that.
All the assets of the businessneed to be used in the business.
And then the last hurdle isthat it has to be a qualified
trader business, and so the codelists out what is considered,
(06:42):
what is not considered aqualified trader business and
that is your service company.
So healthcare, engineering,accounting, things like that Any
services where the reputationor skill of one or more of the
employees is the main asset ofthe business.
So service businesses are notqualified.
Other financial businessesbanking, things like that do not
(07:03):
qualify.
Farming does not qualify, andhotels, restaurants and other
businesses like that do notqualify.
But basically anything elseshould be able to qualify under
1202.
So now you've passed all thosetests, you have a qualifying
small business.
The next test is that you haveto in the hands of the
shareholder.
It has to be consideredqualified small business stock,
(07:26):
and so the shareholder must bean individual.
Trust, estate or partnershipCan't be a corporate shareholder
.
It must be original issuancestock so no one else could have
owned the stock before you.
There are definitely someexceptions to this we could
probably do a whole podcast onthat but it's got to be original
issuance stock and you have tohave held it for at least five
(07:47):
years.
So if you go over all thosehurdles, you now have qualified
small business stock.
Speaker 2 (07:54):
So, Phil, do states also allow QSBS exclusion?
Speaker 3 (07:58):
So the answer to that is yes and no.
It depends on the state.
Every state has its own set ofrules and laws.
Most do, some don't.
The big states.
That is yes and no.
It depends on the state.
Every state has its own set ofrules and laws.
Most do, some don't.
The big states that don'tCalifornia, new Jersey,
pennsylvania and some stateshave a hybrid, for example, in
Massachusetts up until 2022,.
It's a hybrid.
Massachusetts only conformedwith the Internal Revenue Code
(08:19):
up until 2005.
So in Massachusetts you couldsell your business and you could
have a 100% exclusion on theFed side.
But in Massachusetts, becauseMassachusetts only conformed up
to 2005, it would only be a 50%exclusion in Massachusetts.
They did change that and so nowyou can get both 100% exclusion
(08:39):
on the federal as well asMassachusetts.
And that's a really big dealbecause now, with the
millionaire's tax inMassachusetts on any income over
a million, there's anadditional 4% tax.
So if we take into account your$10 million sale, you have your
capital gains rate of 20%.
That's a $2 million savings.
You have the net investment tax.
That's another $380,000 ofsavings.
(08:59):
And then in Massachusetts,that's a $2 million savings.
You have the net investment tax.
That's another $380,000 ofsavings and then in
Massachusetts it's a potentialanother $900,000 in savings.
So we're getting close to $3.3million savings on your $10
million gain by having this 1202in Massachusetts.
Speaker 2 (09:15):
Now is it possible to convert an already existing
business into a QSBS.
Speaker 3 (09:22):
Yes, a lot of times these startups will begin as
partnerships, as LLCs, and theywill operate as an LLC, as a
partnership, and the members ofthe partnership may decide that
they want to pursue 1202, andthey can elect to convert that
partnership into a C corporation.
As long as they meet all theother hurdles of being qualified
(09:43):
small business, then yes, youcan convert an LLC partnership
into a C corp and have 1202stock.
The only drawback there is thatthe five-year holding period
starts when you convert, so youcan't convert and then
immediately sell and get your1202 exclusion.
You have to convert and thenwait your five years and then
you can sell to and thenimmediately sell and get your
1202 exclusion.
You have to convert and thenwait your five years and then
you can sell to get theexclusion.
Speaker 2 (10:06):
So, bill, can I give QSBS stock to my children?
Speaker 3 (10:11):
Yes, that is one of the things for original issuance
.
You can inherit, you can gift1202 stock.
One of the planning strategiesthere is that every individual
gets that $10 million exclusion.
If I was the only owner of thisbusiness, I would get my 10
million and that was it.
If, let's say, I sold it for 50and I had a $50 million gain,
(10:32):
but if I wanted to gift my twokids stock, they would also each
get that $10 million exclusion.
So it's a way to spread thatgain around and limit the tax
for the family and things likethat.
Speaker 2 (10:46):
Well, catch you on the next episode.
Phil, I hope you have afantastic rest of your day.
Speaker 3 (10:52):
Thank you, you too.
Speaker 1 (10:55):
Thanks for listening to the Knowing what Counts
podcast.
Ready to optimize your wealthand protect your future, visit
TheMPGroupCPAcom or call413-739-1800 to connect with our
team of experts.
Remember, success is aboutknowing what counts.
Welcome to the Knowing what Counts podcast, the
place where expert guidancemeets smart financial decisions.
Whether you're a high net worthindividual or a thriving
business, the experts at MPCPAsare here to help you protect and
optimize your wealth.
Let's get started, becausesuccess begins with Knowing what
(00:22):
Counts.
Because success begins withknowing what counts.
Speaker 2 (00:31):
Could a little-known tax provision help you save big
on capital gains?
In this episode of Knowing whatCounts podcast, we explore
Section 1202, stock what it is,who qualifies and how it can
improve significant taxadvantages for business owners
and investors.
Don't miss this deep dive intoone of the most valuable tools
for entrepreneurs looking tomaximize their exit strategy.
(00:54):
Welcome back everyone.
I'm Sofia Yvette, co-host slashproducer, back in the studio
with Phil Giger, partner atMPCPAs.
So, phil, how's it going?
Speaker 3 (01:06):
I'm good.
How are you doing today, Sophia?
Speaker 2 (01:09):
I'm doing well, Phil.
Speaker 3 (01:10):
Great.
Speaker 2 (01:11):
So go ahead and introduce yourself to our
listeners today, Sure.
Speaker 3 (01:17):
So my name is Phil Jaguer.
I'm a partner here at MPCPAs.
I've been here since 2006.
We're a full-service firm, butI specialize mostly in high net
worth individuals with a focuson private equity.
I also work with a lot ofclosely held family businesses
and help advise them on theirtax strategies.
Speaker 2 (01:39):
So, Phil, what is QSBS and what does it aim to
accomplish?
Speaker 3 (01:45):
So QSBS is defined by Code Section 1202.
It is a very large topic.
We could probably do two hourson this, but I won't make anyone
do that.
It is a tax incentive for theowners of small businesses on
their exit, on their sale oftheir small businesses.
The owners of small businesseson their exit, on their sale of
(02:07):
their small businesses.
It was introduced in 1993 as anincentive for entrepreneurs and
investors to invest in thesetypes of small businesses.
Speaker 2 (02:15):
What are the key benefits for investors?
Speaker 3 (02:19):
So the key benefit for investors in these small
businesses is a tax benefit, soit's the greater of $10 million
or 10 times your basis in thestock when you sell.
If you had a $10 million gainon the sale of your business,
you'd be able to exclude all ofthat gain from your tax return
(02:40):
in the year you sell yourbusiness.
If you take that $10 millionand you multiply it by the
capital gains rate of 20%,that's a $2 million savings on
the sale of your business.
The other great thing aboutthis is that is not subject to
the net investment income tax,which is a 3.8% tax on
additional investment income.
All in all, you couldpotentially not pay tax of
(03:03):
$2,380,000 on a $10 million saleof your business.
The other side of that is alsothat it's 10 times your basis,
so it's the greater of.
If you had a taxpayer whoinvested $2 million into the
business to start, then theirpotential 1202 exclusion is 10
times that 20 million, so theycould sell their business for 20
(03:25):
million and still also pay notax on that sale.
So it's a really great planningopportunity for small
businesses.
The other great thing is thatit's a per shareholder exclusion
and so let's just say you had10 equal shareholders of a
business and they sold theirbusiness for $100 million.
(03:45):
They would each get the $10million exclusion and the entire
sale would have no tax.
So it's really a pretty cooltax planning strategy.
Speaker 2 (03:55):
Wow, my goodness, it certainly does sound like it has
some nice benefits.
What has made 1202 so popular?
Nice benefits.
What has made 1202 so popular.
Speaker 3 (04:05):
So to talk about that , we kind of have to go back a
little bit and say why wasn't itpopular, since it's been around
since 1993?
When it first came into beingin 1993, it was not 100%
exclusion, it was only a 50%exclusion.
So on your $10 million gain,you would only be able to
exclude $5 million.
There was also some AMT adbacks.
(04:26):
Not everyone really thought itwas worth all the effort to do
this 1202 stock.
That all changed in 2010 whenCongress changed the exclusion
to 100% and they also removedthe AMT ad back.
So we started seeing more andmore of it after that ad back.
So we started seeing more andmore of it after that and then
(04:46):
in 2013, when the net investmenttax came into play another
reason why you would want to dothis because you can avoid that
3.8% additional tax.
But then the big changehappened in 2017 with the Tax
Cuts and Jobs Act, tcja.
That was the big change becauseit lowered the corporate income
tax rate down from the highestof 35% down to 21%.
(05:08):
It made being a C-Corp andrunning the business as a C-Corp
and operating as a C-Corp muchmore palatable to the
shareholders to not have to payat that high tax rate of 35%.
Tax rate of 35%.
So now we see more and morebusinesses starting up as
C-Corps to take advantage of the1202 because they know they can
(05:29):
have that nice low corporatetax rate.
Speaker 2 (05:31):
So, phil, what are the key requirements to qualify
as QSBS?
Speaker 3 (05:36):
In order to have qualified small business stock,
your business first has to beconsidered a qualifying small
business.
The Internal Revenue Code laysfour hurdles that you have to
get past to be considered aqualified small business.
The first is that you have tobe a domestic C-Corp.
So no foreign corporations, nopartnerships, no S corporations.
You have to be a regular old USC-Corp.
(05:59):
The second test is that youhave to pass the gross assets
test, and so that is both beforeand immediately after you
become a C corp.
The gross assets of thebusiness have to be $50 million
or less.
So these are supposed to be forsmall businesses, so they want
to make sure that you'reconsidered a small business $50
(06:20):
million or less.
The third hurdle is that 80% ofthe assets of the business must
be used in the trade orbusiness.
So third hurdle is that 80% ofthe assets of the business must
be used in the trade or business, so you can't have a bunch of
investments or things like that.
All the assets of the businessneed to be used in the business.
And then the last hurdle isthat it has to be a qualified
trader business, and so the codelists out what is considered,
(06:42):
what is not considered aqualified trader business and
that is your service company.
So healthcare, engineering,accounting, things like that Any
services where the reputationor skill of one or more of the
employees is the main asset ofthe business.
So service businesses are notqualified.
Other financial businessesbanking, things like that do not
(07:03):
qualify.
Farming does not qualify, andhotels, restaurants and other
businesses like that do notqualify.
But basically anything elseshould be able to qualify under
1202.
So now you've passed all thosetests, you have a qualifying
small business.
The next test is that you haveto in the hands of the
shareholder.
It has to be consideredqualified small business stock,
(07:26):
and so the shareholder must bean individual.
Trust, estate or partnershipCan't be a corporate shareholder
.
It must be original issuancestock so no one else could have
owned the stock before you.
There are definitely someexceptions to this we could
probably do a whole podcast onthat but it's got to be original
issuance stock and you have tohave held it for at least five
(07:47):
years.
So if you go over all thosehurdles, you now have qualified
small business stock.
Speaker 2 (07:54):
So, Phil, do states also allow QSBS exclusion?
Speaker 3 (07:58):
So the answer to that is yes and no.
It depends on the state.
Every state has its own set ofrules and laws.
Most do, some don't.
The big states.
That is yes and no.
It depends on the state.
Every state has its own set ofrules and laws.
Most do, some don't.
The big states that don'tCalifornia, new Jersey,
pennsylvania and some stateshave a hybrid, for example, in
Massachusetts up until 2022,.
It's a hybrid.
Massachusetts only conformedwith the Internal Revenue Code
(08:19):
up until 2005.
So in Massachusetts you couldsell your business and you could
have a 100% exclusion on theFed side.
But in Massachusetts, becauseMassachusetts only conformed up
to 2005, it would only be a 50%exclusion in Massachusetts.
They did change that and so nowyou can get both 100% exclusion
(08:39):
on the federal as well asMassachusetts.
And that's a really big dealbecause now, with the
millionaire's tax inMassachusetts on any income over
a million, there's anadditional 4% tax.
So if we take into account your$10 million sale, you have your
capital gains rate of 20%.
That's a $2 million savings.
You have the net investment tax.
That's another $380,000 ofsavings.
(08:59):
And then in Massachusetts,that's a $2 million savings.
You have the net investment tax.
That's another $380,000 ofsavings and then in
Massachusetts it's a potentialanother $900,000 in savings.
So we're getting close to $3.3million savings on your $10
million gain by having this 1202in Massachusetts.
Speaker 2 (09:15):
Now is it possible to convert an already existing
business into a QSBS.
Speaker 3 (09:22):
Yes, a lot of times these startups will begin as
partnerships, as LLCs, and theywill operate as an LLC, as a
partnership, and the members ofthe partnership may decide that
they want to pursue 1202, andthey can elect to convert that
partnership into a C corporation.
As long as they meet all theother hurdles of being qualified
(09:43):
small business, then yes, youcan convert an LLC partnership
into a C corp and have 1202stock.
The only drawback there is thatthe five-year holding period
starts when you convert, so youcan't convert and then
immediately sell and get your1202 exclusion.
You have to convert and thenwait your five years and then
you can sell to and thenimmediately sell and get your
1202 exclusion.
You have to convert and thenwait your five years and then
you can sell to get theexclusion.
Speaker 2 (10:06):
So, bill, can I give QSBS stock to my children?
Speaker 3 (10:11):
Yes, that is one of the things for original issuance
.
You can inherit, you can gift1202 stock.
One of the planning strategiesthere is that every individual
gets that $10 million exclusion.
If I was the only owner of thisbusiness, I would get my 10
million and that was it.
If, let's say, I sold it for 50and I had a $50 million gain,
(10:32):
but if I wanted to gift my twokids stock, they would also each
get that $10 million exclusion.
So it's a way to spread thatgain around and limit the tax
for the family and things likethat.
Speaker 2 (10:46):
Well, catch you on the next episode.
Phil, I hope you have afantastic rest of your day.
Speaker 3 (10:52):
Thank you, you too.
Speaker 1 (10:55):
Thanks for listening to the Knowing what Counts
podcast.
Ready to optimize your wealthand protect your future, visit
TheMPGroupCPAcom or call413-739-1800 to connect with our
team of experts.
Remember, success is aboutknowing what counts.
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