Small Business Corporation Stock: Special Tax Incentives (Portfolio 760)

Tax Management Portfolio, Small Business Corporation Stock: Special Tax Incentives, No. 760-3rd, describes a number of Code provisions providing special incentives to invest in small businesses.

To view this Portfolio, take a free trial to Bloomberg Tax.

Bloomberg Tax

This Portfolio is available with a subscription to Bloomberg Tax, a comprehensive research solution including over 500 Tax Management Portfolios, practice tools, primary sources and timely news.


Tax Management Portfolio, Small Business Corporation Stock: Special Tax Incentives, No. 760-3rd, describes a number of Code provisions providing special incentives to invest in small businesses. Its principal emphasis is the three provisions benefitting various small business corporations. Section 1045 allows the tax-deferred rollover of gain realized on the sale of stock in one qualified small business corporation into stock of another qualified small business corporation. Section 1202 allows a significant, generally 50%, exclusion for gains recognized with respect to stock of qualified small business corporations. Neither of these two is available for investments in S corporations. Section 1244 allows ordinary loss treatment with respect to the stock of small business corporations, both C corporations and S corporations. In addition, this Portfolio describes two provisions of the Code that grant preferential treatment to investments in small business investment companies, which are a class of specialized investment vehicles defined in the Small Business Investment Act. The first provision, §1044, allows the tax-deferred disposition of publicly traded securities to the extent that the proceeds are used to purchase investments in specialized small business investment companies. The second provision, §1244, grants ordinary loss treatment for losses sustained with respect to stock in small business investment companies.


Anthony P. Polito

Anthony P. Polito, Professor of Law, Suffolk University Law School, Boston, MA; S.B. (Economics), Massachusetts Institute of Technology (1986); J.D., Harvard University (1989); LL.M., New York University (1995).

Table of Contents

Detailed Analysis

I. Small Business Corporations - Introduction

Introductory Material

A. Qualified Small Business Corporation vs. Small Business Corporation

B. Taxation and Risk Taking

C. Choice of Entity

D. Capital Structure Issues

II. Section 1244

Introductory Material

A. Only Individuals Are Eligible for § 1244 Treatment

1. Pass-Through Treatment for Partnerships

2. S Corporations Are Not Partnerships

B. Original Issuance Requirement

1. Previously Issued Stock

2. Incorporation of an Operating Partnership

3. Acquisition from Underwriters

C. Transactions Triggering a § 1244 Ordinary Loss

D. Annual Limitation

1. Treatment of Excess

2. Application to Partners

3. Insufficient Ordinary Income to Absorb Loss

III. Section 1244 Stock

Introductory Material

A. Common or Preferred Stock

B. Issued by a Domestic Corporation

C. Small Business Corporation Requirement

1. Transfers of Property

2. Effect of Liabilities

3. Effect of Reduction of Capital

4. Organization Expenses

5. Section 1244 Stock Issued in the Year the Corporation Exceeds the Capital Receipts Limitation

a. Designation

b. Formula Allocation

D. Issued for Money or Other Property

1. Issuance

2. Money or Other Property

a. Stock or Securities Restriction

(1) Definition of “Stock or Securities”

(2) Cancellation of Indebtedness

b. Stock for Services

3. Stock Dividends, Recapitalizations and Changes of Form

a. Stock Dividends

b. Recapitalizations

c. Change of Form

E. The Gross Receipts Test

1. Purpose of This Test

2. Meaning of “Gross Receipts”

3. Exception for a Loss Corporation

4. Definition of Investment Income

a. Royalties

b. Rents

c. Dividends

d. Interest

e. Annuities

f. Sale of Stock or Securities

IV. Additional § 1244 Requirements for Stock Issued On or Before November 6, 1978

Introductory Material

A. Plan Requirement

1. Need for a Written Plan

2. Specification of the Period in the Plan

3. Issuance During Plan Period

4. Maximum Dollar Amount

B. No Prior Offering Outstanding

C. No Subsequent or Simultaneous Offering

D. Small Business Corporation Test - Stock Issued On or Before November 6, 1978

1. Plan Limitation

2. Equity Capital Limitation

V. Increase in Basis of § 1244 Stock

VI. Section 1244 and Transfers of Property with Basis in Excess of Value

Introductory Material

A. May Apply to Ordinary Loss Assets

B. No Effect on Amount of Loss Realized

C. Valuation Problems

D. Transfer of More Than One Item of Property

VII. Record Keeping and Information Requirements Under § 1244

Introductory Material

A. Records Maintained by the Corporation

B. Records Maintained by the Taxpayer

VIII. Rollover of Gain Under § 1045

Introductory Material

A. Basis Rules

B. Holding Periods

C. Manner of Election

IX. Partial Gain Exclusion Under § 1202

Introductory Material

A. Effective Tax Rates on QSB Stock

B. Five-Year Holding Period Requirement

C. Per-Issuer Limitation on Taxpayer's Eligible Gain

1. Basis for Determining the Limitation

2. Status Preserving Transactions

3. Treatment of Married Individuals

D. Alternative Minimum Tax Treatment

E. 60% Exclusion for Empowerment Zone Businesses

X. Operating Rules in § 1045 and 1202

Introductory Material

A. Pass-Through Entities

1. Eligible Pass-Through Entities

2. Pass-Through Treatment

B. Partnership Regulations Under § 1045

1. In General

2. Partnership Election

a. Partnership § 1045 Gain

b. Nonrecognition Limitation

c. Basis Adjustments

d. Opting Out of Partnership-Level Election

e. Notice, Election Procedure, and Reporting

3. Partner Election

a. Partner Purchase of Replacement QSB Stock

b. Partnership Purchase of Replacement QSB Stock

c. Taxpayer Other Than C Corporation

d. Basis Adjustments

e. Partner Recognition of Gain

f. Election

4. Partnership Distributions

5. Contributions of QSB Stock or Replacement QSB Stock

C. Reorganizations and Incorporations

D. Short Positions

1. Offsetting Short Position

2. Limitation on Application Under § 1202

E. Basis Rules

XI. QSB Stock

Introductory Material

A. C Corporation Requirements

B. Original Issuance Requirement

1. Redemption Transactions Negating Original Issuance

a. Redemptions from Related Parties

b. Significant Redemptions

c. Section 304 Redemptions

d. Certain Purchases Ignored

2. Preserving QSB Status

a. Gift or Inheritance

b. Partnership Transfer to a Partner

c. Proposed Regulations for Partnership Distributions of QSB Stock

(1) Distributions Liquidating an Interest or of All of a Type of QSB Stock

(2) Other Distributions

(3) Contributions of QSB Stock to Partnership

d. Carryover Basis Transactions

e. Reorganizations and Incorporations

(1) Limitation

(2) Successive Application

f. Conversion of QSB Stock

C. QSB Requirement

D. Reporting Requirements

E. Active Business Requirement

1. Qualified Trade or Business

2. 80% of Assets by Value

a. Look-Thru for Subsidiaries

b. Start-up and Research Assets

c. Working Capital

d. Computer Software Royalties

3. Disqualifying Assets

4. Eligible Corporation

5. Waiver of the Active Business Requirement

F. Stock Options

XII. Investments in Small Business Investment Companies

Introductory Material

A. Rollover into Specialized Small Business Investment Companies

1. Rollover

2. Election

3. Limitations

a. Individual Limitations

b. Corporate Limitations

B. Losses on Small Business Investment Company Stock

C. Comparison to Provisions Relating to Small Business Companies

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Statement of Corporation Relating to § 1244 Stock

Worksheet 2 Gross Receipts Analysis

Worksheet 3 Information To Be Kept by the Corporation Concerning Its § 1244 Stock

Worksheet 4 Information To Be Kept by the Shareholder of § 1244 Stock

Worksheet 5 Asset Test Under the Active Business Requirement of § 1202

Worksheet 6 Rollover Election Under § 1044



Principal Code Sections:

Principal Treasury Regulations:

Public Laws:

Legislative History:

Revenue Rulings: