Tax Planning for Small Businesses: Understanding Form 8275 and Section 1202
As a business owner, properly managing your taxes is critical to the success of your company. One of the most important tax provisions to understand is Section 1202, which allows taxpayers to exclude capital gains from the sale of Qualified Small Business Stock (QSBS) if certain requirements are met. However, the rules and regulations surrounding this tax provision have become increasingly complex, and the IRS is now scrutinizing QSBS exclusion claims more closely than ever before. In this guide, we will explore the implications of recent IRS guidance and provide tips on how to ensure you are within compliance with the law.
What is Form 8275 and why should you care?
Form 8275 is a statement to the IRS that auditors use to identify potential tax issues on your tax return. When filing Form 8275, you are essentially raising a red flag in front of the IRS and asking for an audit. This approach is generally not recommended unless you have substantial authority for the tax treatment of an item. In other words, if you are confident you are doing everything by the book, you may file Form 8275. Otherwise, it is best to avoid it as it can increase the likelihood of an audit.
Understanding Section 1202 and the latest IRS guidance
Section 1202 is a valuable tax provision for small business owners as it allows for a 100% capital gain exclusion on the sale of QSBS. However, the IRS has recently issued strict guidelines that restrict the scope of this rule. The latest guidance, CCA 202204007, went public on January 28, 2022, and it has significant implications for small businesses seeking to qualify for the QSBS deduction.
One of the key takeaways from the guidance is that the IRS is examining whether a firm is involved in a qualifying trade or business (QTB) to qualify for Section 1202. Every company is a QTB except those designated in section 1202(e), which includes businesses such as healthcare and hospitality. Additionally, the IRS is narrowing the exception for brokerage services, which is one of the strictest gain exclusion rules of Section 1202.
The IRS is defining a broker as one who works as a mediator between buyers and sellers, particularly in negotiating contracts. The definition is being extended to include all types of brokers, regardless of whether they typically define themselves as such. In essence, the IRS is scrutinizing the internet activities of businesses that facilitate lease agreements between prospective lessors and lessees of real estate. If you are providing brokerage services (even if you don’t define it that way), you may be subject to the QSBS deduction.
How can you protect your business?
To avoid an audit and penalties, it is crucial to ensure you are complying with Section 1202 rules. The first step is to maintain excellent bookkeeping and data retrieval ability. Use a cloud platform you can trust and hire or outsource if necessary. Next, make sure to engage with your consultants to ensure sound arguments and keep up to date with the latest rules and regulations surrounding the QSBS deduction and Section 1202.
Additionally, it is recommended to maintain good records and documentation of your QSBS transactions and file Form 8275 only if you have substantial authority for the tax treatment of an item. This means having a 40% success rate and being confident with the approach you’ve taken. In conclusion, the best way to protect yourself and your business is by staying up to date with the rules and regulations surrounding Section 1202, keeping excellent records, and consulting with experts when necessary.
Conclusion
Navigating the intricacies of tax planning can be challenging, especially for small businesses. It is important to understand the implications of recent IRS guidance surrounding Form 8275 and Section 1202, and take proactive steps to protect your business. By using reliable bookkeeping methods, engaging with consultants, and staying informed on the latest rules and regulations, you can protect your business and ensure long-term success.
