Transfers “At Death” Of Qualified Small Business Stock

This article addresses the consequences of “transfers at death” of qualified small business stock (“QSBS”) under Section 1202.

Generally, in order to qualify for Section 1202’s gain exclusion, the stockholder who sells QSBS must be the same stockholder who was issued the QSBS by the qualified small business corporation. There are several exceptions to this requirement, including Section 1202(h)(2)(B), which provides that when there is a transfer “at death,” the transferee is treated as the original stockholder for Section 1202 purposes and is treated as having held the transferred QSBS for the original stockholder’s holding period.

This is one in a series of articles and blogs addressing planning issues relating to qualified small business stock (QSBS) and the workings of Sections 1202 and 1045 of the Internal Revenue Code.[i] During the past several years, there has been an increase in the use of C corporations as the start-up entity of choice. Much of this interest can be attributed to the reduction in the corporate rate from 35% to 21%, but savvy founders and investors have also focused on qualifying for Section 1202’s generous gain exclusion. Any future increases in capital gains rates may result in QSBS eligible investments being even more attractive by comparison.[ii]

What does transferred at death mean?
“At death” is not defined for Section 1202 purposes or in any other tax authority expressly interpreting Section 1202.
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Qualified Small Business Stock: One Of The Code’s Most Significant (And Often Overlooked) Tax Breaks

Section 1202 offers a once little-known exclusion from income for gain on qualified small business stock (“QSB stock”).  The provision has undergone substantial revisions over the years and came back into vogue as a result of the Tax Cuts & Jobs Act.  Where applicable, section 1202’s exclusion offers a substantial and legitimate tax shelter: The exclusion of potentially all of the gain on QSB stock held for more than five years.

Section 1202 of the Internal Revenue Code allows a taxpayer (other than a corporation) to exclude a percentage of gain from the sale or exchange of qualified small business stock held for more than 5 years.  The exclusion is subject to a number of intricate requirements.  But where applicable, the exclusion provides one of the Code’s most significant tax breaks.

Section 1202 

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