If someone said you can't have your cake and eat it, they should have called their accountants and lawyers.

Entrepreneurs, equity investment firms and venture capitalists often inquire about ways to save on or avoid capital gains taxes on business sales. Lawyers and accountants encourage their clients to look at the tax savings offered by setting up a qualified small business corporation at the initial business formation stage. If the company is established and stock is issued, capital gains tax can be eliminated.

Tech founders should consider the long-term tax savings afforded by IRS Code Section 1202 if they choose to use S-Corporations, partnerships, and limited liability companies.

The main requirements and tax savings provided by forming a startup entity structured to maximize the capital gains tax exclusion are outlined in this article.

If the stock has been held for more than five years, the capital gains tax on the sale of the stock is excluded. The stock in the C-Corporation was acquired by the taxpayer in exchange for money, property or as compensation for services. At the time of the stock's issuance, the corporation may not have assets that are more than $50 million.

The IRC 1202 gain exclusion allows stockholders, founders, private equity and venture capitalists to claim a minimum $10 million federal income tax exclusion on capital gains for the sale of QSBS.

The portion of the capital gain that was excluded from the tax was an item of tax preference. Before January 1, 2015, the rule was changed so that the gain on the stock was not an item of tax preference. The Protecting Americans from Tax Hikes Act of 2015 made this change permanent.

The tax savings benefit for entrepreneurs and small business investors is a result of the changes to the tax code. The effect of the exclusion depends on a number of factors.

Qualifying for Section 1202’s capital gains tax exclusion takes careful planning

The future stock sale must be structured as a sale of QSBS for federal income tax purposes to be eligible for the capital gains tax exclusion. This can be a challenge, as buyers prefer asset acquisitions that allow a step-up in basis.

In business sales today, buyers expect stockholders to roll over a portion of their equity, or receive stock or membership interests in a new entity as part of the transaction Imprecise planning will cause the QSB stockholders to have to pay taxes on the sale. It can happen if there is an impermissible equity transfer.