Tax-Free Investment Gains

For more than 20 years, Section 1202 of the tax code has offered benefits to investors in certain small companies. Generally, non-corporate investors can use this tax break if they buy stock in companies that met specified criteria. After a holding period of at least 5 years, any gain on a sale will be taxed favorably.

Originally, the tax exclusion applied to 50% of the gain. In 2010, the exclusion was temporarily increased to 100%, for purchases after September 27 of that year; the 100% exclusion was extended but expired after 2014. Now the 100% exclusion on the sale of qualified small business stock (QSBS) is permanent. Another temporary measure—exclusion of QSBS gain from the alternative minimum tax—also is permanent under the PATH Act.

With the recent increase in capital gains tax rates for high-income taxpayers and the possible imposition of the 3.8% Medicare surtax, tax-free gains from a profitable investment may be appealing.