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What are the consequences of a stock dividend under Section 1202?

Qualified Small Business Stock (QSBS) Section 1202 Stock Dividend
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Scott Dolson, JD
A stock dividend involves the distribution by a corporation of shares to existing shareholders with respect to their outstanding shares. Section 305(a) generally provides that a distribution made by a corporation to its shareholders in its stock is nontaxable. As discussed elsewhere in this Article, Section 1202(h)(3) provides that rules similar to those in Section 1244(d)(2) apply to Section 1202. Treasury Regulation Section 1.1244(d)-3 provides that stock dividends generally fall within the scope of Section 1244(d)(2). Under the authority of Section 1202(h)(3), a dividend of stock with respect to outstanding QSBS should also qualify as QSBS. As discussed in more detail in Section G above, there are arguments based on the language of Section 1244 and Treasury Regulation Section 1.1244(d)-3 that the corporation should not be required to satisfy the $50 Million Test a second time when the stock dividend is made. The only Section 1202 eligibility requirements that should be applicable at the time of the stock dividend would be those ongoing Section 1202 eligibility requirements that would need to be satisfied for the original stock to maintain its QSBS qualification (e.g., the continuing use of at least 80% of the corporation’s assets [by value] in the active conduct of a qualified business activity).

With respect to the holding period for shares received in the stock dividend, Section 1223(4)(A) provides that, “[i]n determining the period for which the taxpayer has held stock or rights to acquire stock received on a distribution, if the basis of such stock or rights is determined under Section 307, there shall (under regulations prescribed by the Secretary) be included the period for which he held the stock in the distributing corporation before the receipt of such stock or rights upon such distribution.” Section 307 controls the allocation of basis for any tax-free stock distribution under Section 305(a). Based on this authority, the holding period for the QSBS issued in the stock distribution should include the holding period for QSBS held by the stockholder.
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