Prof. Beckett G. Cantley
Atlanta’s John Marshall Law School


On September 27, 2010, U.S. Pres. Barack Obama signed the Creating Small Business Jobs Act of 2010 (“SBJA”) that contains a temporary amendment to Internal Revenue Code (“IRC”) Section 1202 that permits an eligible corporation’s stock (known as “Qualified Small Business Stock” or “QSBS”) to be sold by the QSBS original issue shareholders without being taxed on the stock sale. The temporary amendment only applies to certain stock acquired after the enactment date of the SBJA and before January 1, 2011.  The deadline was subsequently extended to January 1, 2012.


In general, each QSBS may exclude gain in the amount of the greater of $10 million or 10 times the adjusted basis in the corporation.  With the impending sunset of the 15% capital gains tax rate at the end of 2012, this 100% exclusion from capital gains taxes (as well as the alternative minimum tax) would be a very big financial windfall to business owners with QSBS.


Example:  TP gets into the technology business. TP owns a patent that has an adjusted basis of $5,000 and a qualified asset appraiser has determined that the patent has a current fair market value of $5,000.  When TP contributes the patent to his QSBS in exchange for stock, he pays no tax on the contribution and his stock now has basis equal to $5,000 for IRC Section 1202 purposes.  Five years later, the patent held by the QSBS is worth $10,005,000.  If TP were to sell the QSBS stock for $10,005,000, TP would pay no tax on the sale of the QSBS stock.


For stock to be considered QSBS, the corporation must be a C Corporation with assets of $50 million or less (as calculated under IRC Section 1202) and at least 80% of the corporation’s assets are used in the active conduct of a qualified trade or business.   A trade or business is qualified if it is actively conducted and is not one of the disqualified business lines, including certain professional services, athletics, performing arts, banking and financial enterprises, hotels, motels or restaurants.


There is no “brother-sister” corporation attribution for purposes of determining the $50 million in assets cap per corporation.  Thus, where more than one corporation is formed by the same owner(s) and all of the corporations are sold at the same time, there is no $50 million cap on the entire group as long as each of the corporations alone does not exceed $50 million. Of course, there should be independent business purpose for forming each corporation other than the reduction of income taxation.


There are several ways to structure a business to make the most efficient use of IRC Section 1202 while also meeting valid non-tax business reasons for doing such structuring.  The author’s forthcoming full length article provides an overview of the IRC Section 1202 tax-free business sale provision, the Congressional intent for enacting it, how practitioners are likely to make use of it, the judicial and codified doctrines that may apply to its use, and the policy implications of its use.