By Matthew E. Rappaport, Falcon Rappaport & Berkman PLLC, New York, NY, and Caryn I. Friedman, Ernst & Young LLP, Washington, DC

Section 1202 was enacted in 1993 as an incentive for taxpayers to start and invest in certain small businesses.1 Currently, the statute provides an exclusion from income for any gain from the sale or exchange of “qualified small business stock” (QSBS) acquired after theeffective date of the statute and held for more than five years.2 However, the amount of gain that is excludible from income depends on when the QSBS was originally issued. The gain exclusion is 50% for QSBS issued before February 18, 2009, and 75% for QSBS issued between February 18, 2009 and September 27, 2010.3 The Creating Small Business Jobs Act of 2010 increased the exclusion to 100% of the total gain for all QSBS issued after September 27, 2010.

Despite this additional incentive, many businesses shied away from planning for QSBS because only the stock of C corporations qualified.5 Unless business founders had planned from inception to use the sale of stock as an exit strategy, founders were reluctant to voluntarily impose “double taxation” (i.e., income taxes at both the corporate level and the shareholder level) on the corporation’s taxable income.

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