Small Business Succession Planning? Consider a 1202 QSBS Strategy

By Chris Brown, CIMA®, CRPC™
Vice President — Investments
Synovus Securities, Inc.

Many small businesses are exploring various business succession strategies to create further employee retention, save on taxes, or ensure the viability of their business for future generations.  There are many ways to create thoughtful and tax efficient plans for the future success of your business. Section 1202 of the Internal Revenue Code provides extraordinary tax benefits1 for qualifying small business stock plans,3 allowing entrepreneurs to exclude up to $10 million or 10 times their basis (whichever is greater) from federal capital gains taxes upon sale. This represents potential tax savings of $2.38 million at current federal rates, making QSBS planning an important niche strategy for growing businesses.

Key benefits of a 1202 QSBS strategy

Tax Exclusion: Qualify for 100% federal capital gains tax exclusion on gains up to $10 million per shareholder, per company. For married couples filing jointly, this effectively doubles to $20 million in excludable gains.2

State Tax Benefits: Many states — including California, New York and Texas — also provide favorable treatment or complete exclusion for QSBS gains, further amplifying tax savings.

Stacking Opportunities: Each qualifying company represents a separate $10 million exclusion, allowing serial entrepreneurs to multiply benefits across multiple ventures.

Timing Matters: Stock must be issued before the company's gross assets exceed $50 million. Once this threshold is crossed, no new QSBS can be created, though existing qualifying stock retains its status.

Estate Planning Integration: QSBS benefits can be preserved through estate planning structures, allowing tax-free transfers to heirs while maintaining the exclusion benefits.

Employee Incentives: Structuring employee equity compensation with QSBS-eligible shares creates powerful retention tools and aligns employee interests with long-term company growth.

This may sound too good to be true, of course. It’s not too good to be true, but it may be too good for many to qualify.

The bullet points below provide the primary structures that are required by Internal Revenue Code 1202 for business’ eligibility to take advantage of the 1202 stock issuance and benefits. Though, there may be further nuances involved for a qualifying business, many of the requirements, restrictions and further compliance measurements are displayed below.

Business Entity Requirements:

• C Corporation structure (LLCs and S Corps do not qualify).
• Gross assets of $50 million or less when stock is issued.
• Active business requirement (80% of assets used in qualifying trade or business).
• Establish clear records of original issuance dates and basis.
• Implement equity compensation plans using QSBS-eligible shares.
• Domestic corporation conducting business primarily in the U.S.

Business Activity Restrictions:

• Cannot be primarily engaged in professional services (law, medicine, consulting, financial, etc.).
• Excluded industries include banking, insurance, farming, mining and hospitality.
• Technology, manufacturing, retail, wholesale, and most other active businesses qualify if the business generates revenue from the product or service itself opposed to the expertise or intellectual property of the employees/ business owner(s).

Shareholder Requirements:

• Must acquire stock directly from the company (not secondary purchases).
• Must hold stock for a minimum of five years.
• Original issuance must occur after September 27, 2010 for maximum benefits.

Ongoing Compliance:

• Monitor the 80% active business test quarterly.
• Track gross asset levels to optimize timing of future equity raises.
• Maintain detailed capitalization table with QSBS designation.
• Consider recapitalization strategies before crossing $50 million threshold.

The Section 1202 QSBS strategy represents one of the most significant tax planning opportunities available to small business owners. With proper planning, implementation and ongoing compliance oversight, qualifying businesses can preserve millions in taxes while building long-term value for their family and employees. The key to any successful business transition plan is creating a thorough action plan and understanding what strategies are appropriate for you and your business. Anyone seeking specific information for the 1202 QSBS should also coordinate with a qualified tax professional as well as a business attorney who may be familiar with the 1202 QSBS strategy implementation.