The New Section 1202 Tax-Free Business Sale: Congress Rewards Small Businesses That Survived the Great Recession

On September 27, 2010, President Barack Obama signed the Creating Small Business Jobs Act of 2010 (“SBJA”) that contains a temporary amendment to Internal Revenue Code (“IRC”) § 1202. The amendment permits original shareholders of eligible corporation stock to sell the stock without being taxed on the sale. The temporary amendment initially only applied to certain stock acquired after the enactment of the SBJA and before January 1, 2011, but the amendment was extended on December 17, 2010 for another year ending January 1, 2012. With the impending sunset of the 15% capital gains rate at the end of 2012, this 100% exclusion from both capital gains taxes and the alternative minimum tax (“AMT”), would be a very big financial windfall to business owners with qualified small business stock (“QSBS”). A qualified small business (“QSB”) is a C corporation with assets of $50 million or less where at least 80% of its assets are used in the active conduct of a trade or business other than certain professional, entertainment, and hospitality services. In general, each QSB C corporation may exclude gain in the amount of the greater of $10 million or 10 times the adjusted basis in the corporation. Victor Fleischer stated that the main purpose for enhancing the IRC § 1202 exclusion is to encourage investment in certain new C corporation ventures and small businesses. Manufacturing, construction, and retail wholesaling industries appear to be some of the main areas promoted by the expanded exclusion, since the definition of “qualified trade or business” excludes many other major areas of industry. This Article provides an overview of the IRC Section § 1202 tax-free business sale provision, the history behind the development of the IRC amendments, the apparent intent for enactment, the likelihood the Act will achieve its purposes, the statute’s ambiguities, and some policy implications of creating a tax-free business sale provision.