Stableford Capital Insights

How to Save Millions on Your Personal Tax Return with this Loophole

Big news for small business—if you have shares of stock in a company valued at less than $50 million, you might be eligible to exclude over $10 million in taxes when sold. Qualified small business stock, or Section 1202 stock, can save you millions on your personal tax return.You may be familiar with the usual ways to reduce taxes; trusts are one, gifts and philanthropy are others. What about skipping capital gains on your personal tax return altogether when selling shares? Excluding qualified small-business stock may be the greatest opportunity to reduce taxes yet.

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Who Benefits from this Loophole

Though qualifications are narrow, rewards are great, so it is important to use professional tax services to find out if you may benefit from excluding qualified small-business stock.Usually this loophole benefits those who were in on the ground floor of building a fast-growing business. Founders, investors and first hires who took a chance on something are often in prime positions to take advantage of qualified small-business stock exclusions.What may have started as a small slice of shares at hiring can grow rapidly into millions of dollars in stock. For employees who hang onto this for five years or more, selling this stock may be a tax-free endeavor. Consider this a bonus for a great business decision and a little bit of patience.To be eligible for Section 1202 stock, there are some basic elements that define small business stock:

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  • Purchasers or recipients of stock from companies valued at less than $50 million dollars at receipt.
  • Shares can be given as compensation or bought.
  • Owners must be in possession of stocks for at least five years.
  • The investor cannot be a corporation.
  • The stock cannot come from the secondary market.
  • The majority of assets must go to operations.
  • Stocks from 1993 to present may qualify.

This tax exclusion applies to 10 times invested funds or $10 million, whichever is more.If you think you may have overpaid personal taxes due to qualified small business stock exclusions, you can file an amended return to receive a refund.

Personal Tax Return Amendment

Perhaps you have been overpaying and are owed a refund, like LinkedIn employee Danis Dayanov. He told the New York Times’ Paul Sullivan that he discovered the eligibility of qualified small-business stocks through an automated tax services software program - not his accountant.

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Past overpayment can result in a refund and Dayanov eventually received a refund from the IRS.However, be prepared for an audit. Dayanov faced an audit that lasted over a year. His colleague, Kay Luo, who also worked at LinkedIn, received a refund and is now preparing for the possibility of an audit.Personal tax return services are essential to help navigate possibilities like this.

Loopholes in a Loophole

It’s loopholes all the way down when it comes to qualified small business stocks. Those seeking to qualify for this small business tax benefit must be involved in producing something. As Investopedia notes, this excludes sectors such as hospitality, financial, farming and mining. Yet tech companies are among the greatest beneficiaries. So in the case of a company like Uber, what exactly does it produce?

Not the car rides, as the New York Times explains, but rather the app that fetches the car rides. Tech companies’ products are intangible, but proprietary. Thus, they fall into the caveat of “making something.”This is not the only creative way to benefit from this small business tax opportunity. Another is to use trusts to spread the wealth.If qualified small-business stock eventually exceeds $10 million dollars, it can be divided into trusts. As trusts are a separate entity, they can receive the tax benefit on second, third, fourth, and onward divisions of $10 million, once the owner has surpassed the limit himself.And if any of these options feel too long-term, qualified small business stock can be sold early and re-invested in another organization's qualified stock. Capital gains taxes will be held off during this time.

The High Points of High Savings in Personal Tax Return

Being with a small business from the ground up comes with many rewards, not the least of which now appears through a personal tax return. Taking advantage of excluding qualified small-business stock up to $10 million is just one more in a series of smart business decisions.If you suspect you have left millions of dollars on the table at tax time, talk to an experienced accountant about using this exclusion next year or pursuing an amendment for a refund. Among our many integrated advisory services, Stableford Tax offers Tax Planning to help evaluate potential exclusions such as this on personal tax returns.To review your eligibility on qualified small-business stock tax exclusions, contact Stableford today by calling 480.493.2300 or contact us online.

Mark Barone
Mark Barone has been a tax and accounting specialist for over 28 years. After graduating from the University of Iowa, he joined KPMG as an associate in Chicago before moving to Phoenix in 1999 to work with Deloitte as a manager. Barone then transitioned into private practice for several years prior to opening his own firm. In 2016, he partnered with Stableford Capital Founder Andy Brinkman and fellow CPA Jane Hemminger to launch Stableford Tax. As a leader in the active advisory firm’s tax division, Barone looks forward to helping Stableford’s clients gain access to asset management, financial planning, and tax services under one roof.