Planning Ahead for Taxes When Selling a Small Business 

The way your business is set up now can have a big impact on how much money you keep if you decide to sell later. Section 1202 of the tax code could help you reduce your taxes. If you meet certain rules, you might be able to lower or even avoid some federal taxes on the profit from selling your small business. 

What is Section 1202? 

Section 1202 of the tax code deals with Qualified Small Business Stock, or QSBS for short. 

If your shares meet the requirements, you could exclude part of your profit from federal income tax when you sell the business. Sometimes, you can exclude a large part of the gain, up to certain limits. 

Which businesses may qualify? 

To qualify, a business generally must meet several requirements: 

• It must have $75 million or less in total gross assets at the time shares are issued. 
• It must meet that limit both before and immediately after the stock is issued. 
• It must operate in a qualifying type of business. 

Many companies, especially those in fields like technology or manufacturing, might qualify. But businesses that mainly offer services or focus on financial activities are usually left out. 

Who benefits most? 

Section 1202 is typically most relevant for: 

• Founders. 
• Early employees. 
• Early investors. 

Often, the company gives qualifying shares directly to founders, early employees or early investors when they put in money or work at the start. Shares bought later from someone else usually don’t qualify. When and how you get your shares can affect whether you qualify. 

Why timing and ownership matter 

How long you hold your shares also matters for the possible tax benefit: 

• Longer holding periods may increase the amount of gain eligible for exclusion. 
• Holding shares for five years or more is often associated with the full exclusion. 

When you get your shares and how long you keep them can directly affect your taxes when you sell. 

How much could be excluded? 

The amount you can exclude from taxes can be significant, depending on your situation. 

In general, the amount that may be excluded is the greater of: 

• $15 million, or 
• Up to 10 times the original investment in the shares, if that amount is higher. 

This limit applies to each company separately, so it’s checked for every qualifying business on its own. 

What if you sell early? 

If you sell your shares before meeting the holding period, you might be able to delay paying taxes by putting the money into another qualifying business within a set time. This method doesn’t remove taxes right away, but it could let you get tax benefits later. 

Why early planning matters 

A lot of choices that affect Section 1202 eligibility happen early in a business’s life. Things like your business structure, how you give out ownership and what your business does all matter. Once you make these choices, they can be hard to change later. That’s why your chance for this tax benefit is often set long before you even think about selling. 

Additional considerations: 

• The exclusion applies to federal taxes. State tax treatment may vary. 
• The rules are detailed, and all requirements must be met to qualify. 
• Not all forms of equity are eligible until shares have been formally issued. 

Section 1202 shows how early planning can affect your taxes. Even though it doesn’t fit every case, knowing how your business is set up now can help you make better choices for the future. 

Watch this podcast episode to learn more: Choosing Your Business Entity: The Tax Decisions That Last 

Frequently asked questions 

Does every business qualify for Section 1202? 

No. Whether you qualify depends on things like your business type, how it runs, and how it’s set up. Businesses that mostly offer professional services or focus on financial activities are usually not included. 

Do I need to be a founder to benefit? 

Not always. Founders often benefit, but early employees and investors can also qualify if they got their shares directly from the company and meet the other rules. 

What happens if my business isn’t a C corporation? 

Section 1202 only applies to C corporations and LLCs taxed as C corporations. Still, every situation is different, and choosing your business type involves several factors. 

Is it too late to plan if my business is already established? 

It depends. Some things can be changed, but others are set by earlier choices. Looking at your current setup can show what options you still have. 

Does this apply to state taxes as well? 

Not always. Section 1202 is about federal taxes. State tax rules are different and might not match. 

If you’re thinking about selling your business in the future, talk with a financial professional about how your business is set up now. 

Disclosures 

Representatives of Ameritas do not provide tax or legal advice. Please consult your tax advisor or attorney regarding your specific situation. 

Information gathered from external sources is believed to be reliable; however, we make no representations as to its completeness or accuracy. This information should not be construed as investment, legal, or tax advice.