Section 1202 of the Internal Revenue Code allows non-corporate taxpayers to exclude gain from the sale or exchange of qualified small business stock (“QSBS”) in a C Corporation, provided certain conditions are met.
In order to qualify as QSBS, the stock must have been originally issued by the C Corporation to the taxpayer (or may have been acquired by gift or inheritance if the stock was originally issued to the transferor), the C Corporation meets the requirements of a qualified small business, and the C Corporation is engaged in an active business.
If a taxpayer meets these requirements, and certain other requirements, and the taxpayer sells his or her QSBS, the taxpayer can exclude 50% of his or her gain after holding the stock for three (3) years; 75% of his or her gain after holding the stock for four (4) years; and 100% of the gain after holding the stock for five (5) years. This gain exclusion is limited to the greater of $15 million or ten (10) times the taxpayer’s basis in the stock.
Unfortunately for Illinois taxpayers, for tax years ending on or after December 31, 2026, Illinois is decoupling from Section 1202. While Illinois taxpayers can still take advantage of Section 1202 on their federal tax returns, when they prepare their Illinois income tax returns, they will need to include the full gain on the sale of QSBS in their Illinois base income.
Section 1202 remains an advantageous provision for qualifying taxpayers. If you are considering selling your C Corporation, be sure to evaluate whether you might be able to structure to the transaction to take advantage of QSBS – even if you cannot use this benefit for Illinois income tax purposes.
Reach out to our Sandberg Phoenix tax law team to learn more on this topic.
