Gains on sales of QSB stock in light of secs. 1045 and 1202.

• Author: Velotta, Robert A.
• Position: Qualified small business stock

Two Code provisions offer opportunities to defer or exclude gains on the sale or exchange of qualified small business (QSB) stock. Sec. 1202 provides a partial exclusion of gain and, under Sec. 1045, gain is deferred when the proceeds of a QSB stock sale are reinvested in other QSB stock.

Overview

Under Sec. 1202(c), (d)(1) and (e)(4), QSB stock is any stock in a QSB originally issued after Aug. 9, 1993 (the enactment date of the Revenue Reconciliation Act of 1993). A QSB is any domestic C corporation other than a domestic international sales corporation (DISC) or former DISC, a regulated investment company (RIC), a real estate investment trust, a real estate mortgage investment conduit, a cooperative, or a corporation that has elected the Puerto Rico possession tax credit under Sec. 936 and whose aggregate gross assets did not exceed $50 million both before and immediately after the issue date. In addition, the corporation's gross assets cannot have exceeded $50 million at any time after Aug. 9, 1993, and at least 80% of the value of its assets must be used in a qualified trade or business; see Sec. 1202(d)(1) and (e)(1).

Under Sec. 1202(e)(3), a "qualified trade or business" is any trade or business other than health, law, engineering or architectural services, etc., or any other trade or business whose principal asset is the reputation or skill of one or more of its employees. Also excluded from the definition are banking, insurance, financing, leasing, investing or similar businesses; farming; mineral extraction; and the operation of a hotel, motel, restaurant or similar business. Under Sec. 1202(c)(2)(A), this active business requirement must be met for substantially all of the stockholding period. Finally, to qualify as a QSB under Sec. 1202(d)(1)(C), the corporation must agree to any IRS reporting requirements.

Under Sec. 1202(c)(1)(B), QSB stock must be acquired at its original issue for money or property (other than stock), or as compensation directly for services provided to the QSB (other than those of an underwriter of the stock). A taxpayer who acquires QSB stock by gift or inheritance or from a partnership distribution is treated as having acquired it in the same manner as the transferor and has to include the transferor's holding period in calculating eligibility for the Sec. 1202 exclusion. A partnership may distribute QSB stock to its partners, as long as the partner held its partnership interest when the QSB stock was...