In the throes of the end of last year, when people were trying to figure out whether to incorporate a C Corporation before year end to try to set themselves up to qualify for the Section 1202qualified small business stock 100% exclusion from tax benefit (subject to a $10M cap), I heard the following claim made:

“You can only exclude 10x your basis in your stock. Thus, if you are a founder, and your basis in your stock is very, very low–the exclusion isn’t worth much.”

If the above statement was true, the Section 1202 exclusion for qualified small business stock would indeed not be much of a benefit for founders, who typically don’t have a large cost basis in their shares.

Most founders might pay just a few thousand dollars for their founder shares. If a founder paid $2,000 for his or her shares, and the most they could exclude from tax was 10x that, the exclusion would only shelter potentially up to $20,000 in income from tax.

If you could only exclude 10x your basis in your shares from tax, Section 1202 would indeed be a meager prize.

But is the above statement true?


Section 1202 reads as follows:

(b) Per-issuer limitation on taxpayer’s eligible gain

(1) In general

If the taxpayer has eligible gain for the taxable year from 1 or more dispositions of stock issued by any corporation, the aggregate amount of such gain from dispositions of stock issued by such corporation which may be taken into account under subsection (a) for the taxable year shall not exceed the greater of—

(A) $10,000,000 reduced by the aggregate amount of eligible gain taken into account by the taxpayer under subsection (a) for prior taxable years and attributable to dispositions of stock issued by such corporation, or

(B) 10 times the aggregate adjusted bases of qualified small business stock issued by such corporation and disposed of by the taxpayer during the taxable year.

For purposes of subparagraph (B), the adjusted basis of any stock shall be determined without regard to any addition to basis after the date on which such stock was originally issued.

Thus, you get the greater of 10x or $10M. Rest assured founders, the benefit is ample if you qualify.