AICPA Requests Qualified Small Business Stock (QSBS, Sec 1202) Clarity
[First covered by Isaac Obannon via CPA Practice Advisor]
The AICPA recently submitted detailed comments to the U.S. Department of the Treasury and the IRS, emphasizing the urgent need for clarity and guidance on section 1202 of the Internal Revenue Code, which governs the partial exclusion of gain from certain small business stock (QSBS). This section, enacted in 1993, is intended to incentivize investment in small businesses by offering substantial tax benefits. However, as the AICPA highlights, the lack of established guidance and frequent ambiguities in the statute have left many taxpayers and advisors hesitant to rely on it effectively.
The letter underscores that section 1202 provides a valuable exclusion of 50% to 100% of the gain on QSBS held for over five years, depending on the issuance date of the stock. Yet, despite its substantial tax advantages, it remains underutilized. The AICPA specifically notes that "section 1202 has not been subject to robust guidance or substantial commentary, leaving a significant gap in practical understanding and application".
(You can read the text of the comment letter, here)
$50 Million Gross Asset Limitation
The AICPA requests clarity on the definition of "predecessor corporations" and recommends limiting this term to corporations transferring substantially all their assets in tax-free transactions under sections 118, 351, or 381. This clarification would address uncertainties about which entities fall within this definition and how they impact the $50 million asset test.
The organization also seeks guidance on interpreting "immediately after" in the context of the $50 million test, proposing a "binding commitment" standard to mitigate confusion when multiple stock issuances occur at different times.
Active Business Requirement
Section 1202 requires QSBS issuers to use at least 80% of their assets in the active conduct of a qualified trade or business. However, the AICPA notes that the statutory language defining qualified trades or businesses (QTOBs) is often ambiguous. They suggest adopting definitions from section 199A regulations to provide a clearer framework.
The AICPA also recommends safe harbors for meeting the 80% test and specific exclusions for money market funds under the 10% portfolio test, emphasizing that these measures would reduce the administrative burden on QSBS issuers and increase confidence in compliance.
Corporate Transactions
The AICPA highlights issues with the treatment of corporate reorganizations and stock exchanges, recommending that transactions under section 1202(h)(3) not be subject to limitations under section 1202(h)(4)(B). They argue that these transactions typically involve a single corporation and should not be penalized by rules designed for multi-entity transactions.
The AICPA emphasizes that the current lack of guidance leaves taxpayers exposed to potential disputes, which could discourage them from pursuing investments that section 1202 was designed to promote. For example, the letter notes that even simple issues, such as defining "working capital" or reconciling valuation methods with GAAP, create unnecessary obstacles. They urge the IRS to adopt safe harbors and clarifications that reflect the practical realities of small business investment and operations.
By addressing these ambiguities, the AICPA argues, Treasury and the IRS could significantly enhance the utility of section 1202. The letter reflects a broader concern that without meaningful guidance, section 1202 will remain underutilized, depriving small businesses of vital investment and taxpayers of potential benefits.
