
From the U.S. Code Online via GPO Access
[wais.access.gpo.gov]
[Laws in effect as of January 2, 2001]
[Document affected by Public Law 106-554 Section 1(a)(7)]
[Document affected by Public Law 106-554 Section 1(a)(7)[117(a)]]
[CITE: 26USC1202]

 
                     TITLE 26--INTERNAL REVENUE CODE
 
                        Subtitle A--Income Taxes
 
                  CHAPTER 1--NORMAL TAXES AND SURTAXES
 
                 Subchapter P--Capital Gains and Losses
 
                   PART I--TREATMENT OF CAPITAL GAINS
 
Sec. 1202. Partial exclusion for gain from certain small 
        business stock
        

(a) Exclusion

                           (1) In general

        In the case of a taxpayer other than a corporation, gross income 
    shall not include 50 percent of any gain from the sale or exchange 
    of qualified small business stock held for more than 5 years.

                   (2) Empowerment zone businesses

        (A) In general

            In the case of qualified small business stock acquired after 
        the date of the enactment of this paragraph in a corporation 
        which is a qualified business entity (as defined in section 
        1397C(b)) during substantially all of the taxpayer's holding 
        period for such stock, paragraph (1) shall be applied by 
        substituting ``60 percent'' for ``50 percent''.

        (B) Certain rules to apply

            Rules similar to the rules of paragraphs (5) and (7) of 
        section 1400B(b) shall apply for purposes of this paragraph.

        (C) Gain after 2014 not qualified

            Subparagraph (A) shall not apply to gain attributable to 
        periods after December 31, 2014.

        (D) Treatment of DC zone

            The District of Columbia Enterprise Zone shall not be 
        treated as an empowerment zone for purposes of this paragraph.

(b) Per-issuer limitation on taxpayer's eligible gain

                           (1) In general

        If the taxpayer has eligible gain for the taxable year from 1 or 
    more dispositions of stock issued by any corporation, the aggregate 
    amount of such gain from dispositions of stock issued by such 
    corporation which may be taken into account under subsection (a) for 
    the taxable year shall not exceed the greater of--
            (A) $10,000,000 reduced by the aggregate amount of eligible 
        gain taken into account by the taxpayer under subsection (a) for 
        prior taxable years and attributable to dispositions of stock 
        issued by such corporation, or
            (B) 10 times the aggregate adjusted bases of qualified small 
        business stock issued by such corporation and disposed of by the 
        taxpayer during the taxable year.

    For purposes of subparagraph (B), the adjusted basis of any stock 
    shall be determined without regard to any addition to basis after 
    the date on which such stock was originally issued.

                          (2) Eligible gain

        For purposes of this subsection, the term ``eligible gain'' 
    means any gain from the sale or exchange of qualified small business 
    stock held for more than 5 years.

                (3) Treatment of married individuals

        (A) Separate returns

            In the case of a separate return by a married individual, 
        paragraph (1)(A) shall be applied by substituting ``$5,000,000'' 
        for ``$10,000,000''.

        (B) Allocation of exclusion

            In the case of any joint return, the amount of gain taken 
        into account under subsection (a) shall be allocated equally 
        between the spouses for purposes of applying this subsection to 
        subsequent taxable years.

        (C) Marital status

            For purposes of this subsection, marital status shall be 
        determined under section 7703.

(c) Qualified small business stock

    For purposes of this section--

                           (1) In general

        Except as otherwise provided in this section, the term 
    ``qualified small business stock'' means any stock in a C 
    corporation which is originally issued after the date of the 
    enactment of the Revenue Reconciliation Act of 1993, if--
            (A) as of the date of issuance, such corporation is a 
        qualified small business, and
            (B) except as provided in subsections (f) and (h), such 
        stock is acquired by the taxpayer at its original issue 
        (directly or through an underwriter)--
                (i) in exchange for money or other property (not 
            including stock), or
                (ii) as compensation for services provided to such 
            corporation (other than services performed as an underwriter 
            of such stock).

                (2) Active business requirement; etc.

        (A) In general

            Stock in a corporation shall not be treated as qualified 
        small business stock unless, during substantially all of the 
        taxpayer's holding period for such stock, such corporation meets 
        the active business requirements of subsection (e) and such 
        corporation is a C corporation.

        (B) Special rule for certain small business investment companies

            (i) Waiver of active business requirement

                Notwithstanding any provision of subsection (e), a 
            corporation shall be treated as meeting the active business 
            requirements of such subsection for any period during which 
            such corporation qualifies as a specialized small business 
            investment company.
            (ii) Specialized small business investment company

                For purposes of clause (i), the term ``specialized small 
            business investment company'' means any eligible corporation 
            (as defined in subsection (e)(4)) which is licensed to 
            operate under section 301(d) of the Small Business 
            Investment Act of 1958 (as in effect on May 13, 1993).

        (3) Certain purchases by corporation of its own stock

        (A) Redemptions from taxpayer or related person

            Stock acquired by the taxpayer shall not be treated as 
        qualified small business stock if, at any time during the 4-year 
        period beginning on the date 2 years before the issuance of such 
        stock, the corporation issuing such stock purchased (directly or 
        indirectly) any of its stock from the taxpayer or from a person 
        related (within the meaning of section 267(b) or 707(b)) to the 
        taxpayer.

        (B) Significant redemptions

            Stock issued by a corporation shall not be treated as 
        qualified business stock if, during the 2-year period beginning 
        on the date 1 year before the issuance of such stock, such 
        corporation made 1 or more purchases of its stock with an 
        aggregate value (as of the time of the respective purchases) 
        exceeding 5 percent of the aggregate value of all of its stock 
        as of the beginning of such 2-year period.

        (C) Treatment of certain transactions

            If any transaction is treated under section 304(a) as a 
        distribution in redemption of the stock of any corporation, for 
        purposes of subparagraphs (A) and (B), such corporation shall be 
        treated as purchasing an amount of its stock equal to the amount 
        treated as such a distribution under section 304(a).

(d) Qualified small business

    For purposes of this section--

                           (1) In general

        The term ``qualified small business'' means any domestic 
    corporation which is a C corporation if--
            (A) the aggregate gross assets of such corporation (or any 
        predecessor thereof) at all times on or after the date of the 
        enactment of the Revenue Reconciliation Act of 1993 and before 
        the issuance did not exceed $50,000,000,
            (B) the aggregate gross assets of such corporation 
        immediately after the issuance (determined by taking into 
        account amounts received in the issuance) do not exceed 
        $50,000,000, and
            (C) such corporation agrees to submit such reports to the 
        Secretary and to shareholders as the Secretary may require to 
        carry out the purposes of this section.

                     (2) Aggregate gross assets

        (A) In general

            For purposes of paragraph (1), the term ``aggregate gross 
        assets'' means the amount of cash and the aggregate adjusted 
        bases of other property held by the corporation.

        (B) Treatment of contributed property

            For purposes of subparagraph (A), the adjusted basis of any 
        property contributed to the corporation (or other property with 
        a basis determined in whole or in part by reference to the 
        adjusted basis of property so contributed) shall be determined 
        as if the basis of the property contributed to the corporation 
        (immediately after such contribution) were equal to its fair 
        market value as of the time of such contribution.

                        (3) Aggregation rules

        (A) In general

            All corporations which are members of the same parent-
        subsidiary controlled group shall be treated as 1 corporation 
        for purposes of this subsection.

        (B) Parent-subsidiary controlled group

            For purposes of subparagraph (A), the term ``parent-
        subsidiary controlled group'' means any controlled group of 
        corporations as defined in section 1563(a)(1), except that--
                (i) ``more than 50 percent'' shall be substituted for 
            ``at least 80 percent'' each place it appears in section 
            1563(a)(1), and
                (ii) section 1563(a)(4) shall not apply.

(e) Active business requirement

                           (1) In general

        For purposes of subsection (c)(2), the requirements of this 
    subsection are met by a corporation for any period if during such 
    period--
            (A) at least 80 percent (by value) of the assets of such 
        corporation are used by such corporation in the active conduct 
        of 1 or more qualified trades or businesses, and
            (B) such corporation is an eligible corporation.

               (2) Special rule for certain activities

        For purposes of paragraph (1), if, in connection with any future 
    qualified trade or business, a corporation is engaged in--
            (A) start-up activities described in section 195(c)(1)(A),
            (B) activities resulting in the payment or incurring of 
        expenditures which may be treated as research and experimental 
        expenditures under section 174, or
            (C) activities with respect to in-house research expenses 
        described in section 41(b)(4),

    assets used in such activities shall be treated as used in the 
    active conduct of a qualified trade or business. Any determination 
    under this paragraph shall be made without regard to whether a 
    corporation has any gross income from such activities at the time of 
    the determination.

                   (3) Qualified trade or business

        For purposes of this subsection, the term ``qualified trade or 
    business'' means any trade or business other than--
            (A) any trade or business involving the performance of 
        services in the fields of health, law, engineering, 
        architecture, accounting, actuarial science, performing arts, 
        consulting, athletics, financial services, brokerage services, 
        or any trade or business where the principal asset of such trade 
        or business is the reputation or skill of 1 or more of its 
        employees,
            (B) any banking, insurance, financing, leasing, investing, 
        or similar business,
            (C) any farming business (including the business of raising 
        or harvesting trees),
            (D) any business involving the production or extraction of 
        products of a character with respect to which a deduction is 
        allowable under section 613 or 613A, and
            (E) any business of operating a hotel, motel, restaurant, or 
        similar business.

                      (4) Eligible corporation

        For purposes of this subsection, the term ``eligible 
    corporation'' means any domestic corporation; except that such term 
    shall not include--
            (A) a DISC or former DISC,
            (B) a corporation with respect to which an election under 
        section 936 is in effect or which has a direct or indirect 
        subsidiary with respect to which such an election is in effect,
            (C) a regulated investment company, real estate investment 
        trust, REMIC, or FASIT, and
            (D) a cooperative.

                   (5) Stock in other corporations

        (A) Look-thru in case of subsidiaries

            For purposes of this subsection, stock and debt in any 
        subsidiary corporation shall be disregarded and the parent 
        corporation shall be deemed to own its ratable share of the 
        subsidiary's assets, and to conduct its ratable share of the 
        subsidiary's activities.

        (B) Portfolio stock or securities

            A corporation shall be treated as failing to meet the 
        requirements of paragraph (1) for any period during which more 
        than 10 percent of the value of its assets (in excess of 
        liabilities) consists of stock or securities in other 
        corporations which are not subsidiaries of such corporation 
        (other than assets described in paragraph (6)).

        (C) Subsidiary

            For purposes of this paragraph, a corporation shall be 
        considered a subsidiary if the parent owns more than 50 percent 
        of the combined voting power of all classes of stock entitled to 
        vote, or more than 50 percent in value of all outstanding stock, 
        of such corporation.

                         (6) Working capital

        For purposes of paragraph (1)(A), any assets which--
            (A) are held as a part of the reasonably required working 
        capital needs of a qualified trade or business of the 
        corporation, or
            (B) are held for investment and are reasonably expected to 
        be used within 2 years to finance research and experimentation 
        in a qualified trade or business or increases in working capital 
        needs of a qualified trade or business,

    shall be treated as used in the active conduct of a qualified trade 
    or business. For periods after the corporation has been in existence 
    for at least 2 years, in no event may more than 50 percent of the 
    assets of the corporation qualify as used in the active conduct of a 
    qualified trade or business by reason of this paragraph.

                  (7) Maximum real estate holdings

        A corporation shall not be treated as meeting the requirements 
    of paragraph (1) for any period during which more than 10 percent of 
    the total value of its assets consists of real property which is not 
    used in the active conduct of a qualified trade or business. For 
    purposes of the preceding sentence, the ownership of, dealing in, or 
    renting of real property shall not be treated as the active conduct 
    of a qualified trade or business.

                   (8) Computer software royalties

        For purposes of paragraph (1), rights to computer software which 
    produces active business computer software royalties (within the 
    meaning of section 543(d)(1)) shall be treated as an asset used in 
    the active conduct of a trade or business.

(f) Stock acquired on conversion of other stock

    If any stock in a corporation is acquired solely through the 
conversion of other stock in such corporation which is qualified small 
business stock in the hands of the taxpayer--
        (1) the stock so acquired shall be treated as qualified small 
    business stock in the hands of the taxpayer, and
        (2) the stock so acquired shall be treated as having been held 
    during the period during which the converted stock was held.

(g) Treatment of pass-thru entities

                           (1) In general

        If any amount included in gross income by reason of holding an 
    interest in a pass-thru entity meets the requirements of paragraph 
    (2)--
            (A) such amount shall be treated as gain described in 
        subsection (a), and
            (B) for purposes of applying subsection (b), such amount 
        shall be treated as gain from a disposition of stock in the 
        corporation issuing the stock disposed of by the pass-thru 
        entity and the taxpayer's proportionate share of the adjusted 
        basis of the pass-thru entity in such stock shall be taken into 
        account.

                          (2) Requirements

        An amount meets the requirements of this paragraph if--
            (A) such amount is attributable to gain on the sale or 
        exchange by the pass-thru entity of stock which is qualified 
        small business stock in the hands of such entity (determined by 
        treating such entity as an individual) and which was held by 
        such entity for more than 5 years, and
            (B) such amount is includible in the gross income of the 
        taxpayer by reason of the holding of an interest in such entity 
        which was held by the taxpayer on the date on which such pass-
        thru entity acquired such stock and at all times thereafter 
        before the disposition of such stock by such pass-thru entity.

    (3) Limitation based on interest originally held by taxpayer

        Paragraph (1) shall not apply to any amount to the extent such 
    amount exceeds the amount to which paragraph (1) would have applied 
    if such amount were determined by reference to the interest the 
    taxpayer held in the pass-thru entity on the date the qualified 
    small business stock was acquired.

                        (4) Pass-thru entity

        For purposes of this subsection, the term ``pass-thru entity'' 
    means--
            (A) any partnership,
            (B) any S corporation,
            (C) any regulated investment company, and
            (D) any common trust fund.

(h) Certain tax-free and other transfers

    For purposes of this section--

                           (1) In general

        In the case of a transfer described in paragraph (2), the 
    transferee shall be treated as--
            (A) having acquired such stock in the same manner as the 
        transferor, and
            (B) having held such stock during any continuous period 
        immediately preceding the transfer during which it was held (or 
        treated as held under this subsection) by the transferor.

                    (2) Description of transfers

        A transfer is described in this subsection if such transfer is--
            (A) by gift,
            (B) at death, or
            (C) from a partnership to a partner of stock with respect to 
        which requirements similar to the requirements of subsection (g) 
        are met at the time of the transfer (without regard to the 5-
        year holding period requirement).

                  (3) Certain rules made applicable

        Rules similar to the rules of section 1244(d)(2) shall apply for 
    purposes of this section.

          (4) Incorporations and reorganizations involving 
                             nonqualified stock

        (A) In general

            In the case of a transaction described in section 351 or a 
        reorganization described in section 368, if qualified small 
        business stock is exchanged for other stock which would not 
        qualify as qualified small business stock but for this 
        subparagraph, such other stock shall be treated as qualified 
        small business stock acquired on the date on which the exchanged 
        stock was acquired.

        (B) Limitation

            This section shall apply to gain from the sale or exchange 
        of stock treated as qualified small business stock by reason of 
        subparagraph (A) only to the extent of the gain which would have 
        been recognized at the time of the transfer described in 
        subparagraph (A) if section 351 or 368 had not applied at such 
        time. The preceding sentence shall not apply if the stock which 
        is treated as qualified small business stock by reason of 
        subparagraph (A) is issued by a corporation which (as of the 
        time of the transfer described in subparagraph (A)) is a 
        qualified small business.

        (C) Successive application

            For purposes of this paragraph, stock treated as qualified 
        small business stock under subparagraph (A) shall be so treated 
        for subsequent transactions or reorganizations, except that the 
        limitation of subparagraph (B) shall be applied as of the time 
        of the first transfer to which such limitation applied 
        (determined after the application of the second sentence of 
        subparagraph (B)).

        (D) Control test

            In the case of a transaction described in section 351, this 
        paragraph shall apply only if, immediately after the 
        transaction, the corporation issuing the stock owns directly or 
        indirectly stock representing control (within the meaning of 
        section 368(c)) of the corporation whose stock was exchanged.

(i) Basis rules

    For purposes of this section--

                  (1) Stock exchanged for property

        In the case where the taxpayer transfers property (other than 
    money or stock) to a corporation in exchange for stock in such 
    corporation--
            (A) such stock shall be treated as having been acquired by 
        the taxpayer on the date of such exchange, and
            (B) the basis of such stock in the hands of the taxpayer 
        shall in no event be less than the fair market value of the 
        property exchanged.

              (2) Treatment of contributions to capital

        If the adjusted basis of any qualified small business stock is 
    adjusted by reason of any contribution to capital after the date on 
    which such stock was originally issued, in determining the amount of 
    the adjustment by reason of such contribution, the basis of the 
    contributed property shall in no event be treated as less than its 
    fair market value on the date of the contribution.

(j) Treatment of certain short positions

                           (1) In general

        If the taxpayer has an offsetting short position with respect to 
    any qualified small business stock, subsection (a) shall not apply 
    to any gain from the sale or exchange of such stock unless--
            (A) such stock was held by the taxpayer for more than 5 
        years as of the first day on which there was such a short 
        position, and
            (B) the taxpayer elects to recognize gain as if such stock 
        were sold on such first day for its fair market value.

                    (2) Offsetting short position

        For purposes of paragraph (1), the taxpayer shall be treated as 
    having an offsetting short position with respect to any qualified 
    small business stock if--
            (A) the taxpayer has made a short sale of substantially 
        identical property,
            (B) the taxpayer has acquired an option to sell 
        substantially identical property at a fixed price, or
            (C) to the extent provided in regulations, the taxpayer has 
        entered into any other transaction which substantially reduces 
        the risk of loss from holding such qualified small business 
        stock.

    For purposes of the preceding sentence, any reference to the 
    taxpayer shall be treated as including a reference to any person who 
    is related (within the meaning of section 267(b) or 707(b)) to the 
    taxpayer.

(k) Regulations

    The Secretary shall prescribe such regulations as may be appropriate 
to carry out the purposes of this section, including regulations to 
prevent the avoidance of the purposes of this section through split-ups, 
shell corporations, partnerships, or otherwise.

(Added Pub. L. 103-66, title XIII, Sec. 13113(a), Aug. 10, 1993, 107 
Stat. 422; amended Pub. L. 104-188, title I, Sec. 1621(b)(7), Aug. 20, 
1996, 110 Stat. 1867; Pub. L. 106-554, Sec. 1(a)(7) [title I, 
Sec. 117(a), (b)(2)], Dec. 21, 2000, 114 Stat. 2763, 2763A-604.)

                       References in Text

    The date of the enactment of this paragraph, referred to in subsec. 
(a)(2)(A), is the date of enactment of Pub. L. 106-554, which was 
approved Dec. 21, 2000.
    The date of the enactment of the Revenue Reconciliation Act of 1993, 
referred to in subsecs. (c)(1) and (d)(1)(A), is the date of enactment 
of Pub. L. 103-66, which was approved Aug. 10, 1993.
    Section 301(d) of the Small Business Investment Act of 1958, 
referred to in subsec. (c)(2)(B)(ii), was classified to section 681(d) 
of Title 15, Commerce and Trade, prior to repeal by Pub. L. 104-208, 
div. D, title II, Sec. 208(b)(3)(A), Sept. 30, 1996, 110 Stat. 3009-742.


                            Prior Provisions

    A prior section 1202, acts Aug. 16, 1954, ch. 736, 68A Stat. 320; 
Oct. 4, 1976, Pub. L. 94-455, title XIX, Sec. 1901(b)(33)(M), 90 Stat. 
1802; Nov. 6, 1978, Pub. L. 95-600, title IV, Sec. 402(a), 92 Stat. 
2867; Apr. 1, 1980, Pub. L. 96-222, title I, Sec. 104(a)(2)(A), 94 Stat. 
214, authorized deduction for capital gains, prior to repeal by Pub. L. 
99-514, title III, Sec. 301(a), (c), Oct. 22, 1986, 100 Stat. 2216, 
2218, applicable to taxable years beginning after Dec. 31, 1986.


                               Amendments

    2000--Pub. L. 106-554, Sec. 1(a)(7) [title I, Sec. 117(b)(2)], 
substituted ``Partial'' for ``50-percent'' in section catchline.
    Subsec. (a). Pub. L. 106-554, Sec. 1(a)(7) [title I, Sec. 117(a)], 
amended heading and text of subsec. (a) generally. Prior to amendment, 
text read as follows: ``In the case of a taxpayer other than a 
corporation, gross income shall not include 50 percent of any gain from 
the sale or exchange of qualified small business stock held for more 
than 5 years.''
    1996--Subsec. (e)(4)(C). Pub. L. 104-188 substituted ``REMIC, or 
FASIT'' for ``or REMIC''.


                    Effective Date of 2000 Amendment

    Amendment by Pub. L. 106-554 applicable to stock acquired after Dec. 
21, 2000, see section 1(a)(7) [title I, Sec. 117(c)] of Pub. L. 106-554, 
set out as a note under section 1 of this title.


                    Effective Date of 1996 Amendment

    Amendment by Pub. L. 104-188 effective Sept. 1, 1997, see section 
1621(d) of Pub. L. 104-188, set out as a note under section 26 of this 
title.


                             Effective Date

    Section applicable to stock issued after Aug. 10, 1993, see section 
13113(e) of Pub. L. 103-66, set out as an Effective Date of 1993 
Amendment note under section 53 of this title.

                  Section Referred to in Other Sections

    This section is referred to in sections 1, 45D, 57, 172, 642, 643, 
691, 871, 1044, 1045, 1223, 1397B, 1400B, 1400F, 6652 of this title.
