The Intersection Between Equity Compensation Planning And Section 1202

There are numerous tax and business issues associated with equity compensation planning for employees and other service providers.[i] Numerous tax professionals focus on structuring compensation arrangements and many articles address the key planning issues. But at the same time, very little attention has been focused on structuring equity compensation arrangements for corporations that have issued qualified small business stock (QSBS) to founders and venture capitalists. This article focuses on the intersection between Section 1202’s unique requirements and traditional equity compensation planning.[ii]

This article is one in a series of articles and blogs addressing planning issues relating to QSBS and the workings of Sections 1202 and 1045. During the past several years, there has been an increase in the use of C corporations as the entity of choice for start-ups. Much of this interest can be attributed to the reduction in the federal corporate income tax rate from 35% to 21%, but savvy founders and venture capitalists have also focused on qualifying for Section 1202’s gain exclusion.  Legislation proposed during 2021 sought to curb Section 1202’s benefits, but that legislation stalled along with the balance of the Build Back Better Act. Finally, during August, 2022, Congress passed the Inflation Reduction Act, but that legislation did not amend Section 1202.
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