The Qualified Small Business Stock Exclusion: How Startup Shareholders Get $10 Million (Or More) Tax-Free

COLUMBIA LAW REVIEW FORUM, Forthcoming

11 Pages Posted: 8 Aug 2019

See all articles by Manoj Viswanathan

Manoj Viswanathan

University of California Hastings College of the Law

Date Written: July 16, 2019

Abstract

The IPO parade of 2019 is making the early shareholders of technology startups such as Uber, Lyft, Slack, and Pinterest (among others) staggeringly wealthy. Now that these companies are publicly traded, equity owners can cash out at a huge profit. This profit would normally be taxed at long-term capital gains rates. But the qualified small business stock exclusion of Section 1202 of the Internal Revenue Code, a provision whose ostensible purpose is to promote investment in small businesses, will result in many of these millionaires paying zero federal taxes on much of this sudden wealth.

This Essay demonstrates that the loss in federal tax revenue due to Section 1202 is far greater than previously estimated, with the provision almost exclusively benefitting the wealthy. Section 1202 represents flawed tax policy in that even if catalyzing investment in small businesses is normatively desirable, the provision does little to promote that result. Though putatively applicable to investors in “small businesses,” most truly small businesses are precluded from using Section 1202. Instead, this Essay shows that tech startups with valuations in the billions are common beneficiaries, and suggests how both federal and state actors could mitigate the provision’s effects.

Keywords: 1202, qualified small business stock, capital gains

JEL Classification: K34

Suggested Citation

Viswanathan, Manoj, The Qualified Small Business Stock Exclusion: How Startup Shareholders Get $10 Million (Or More) Tax-Free (July 16, 2019). COLUMBIA LAW REVIEW FORUM, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3432527 or http://dx.doi.org/10.2139/ssrn.3432527

Manoj Viswanathan (Contact Author)

University of California Hastings College of the Law ( email )

200 McAllister Street
San Francisco, CA 94102
United States

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