Question

Does a sale of an S-corporation stock qualify under Sections 1202 and 1244? Both, neither, or one of two? Explain

Answer 1

I will give you the information related to both the sections and you will easily get the answer and concept from that
A taxpayer may be allowed to exclude from taxable income a portion of the gain realized on the sale of qualified small business stock. There are two sections of the Internal Revenue Code that provide such an opportunity. Section 1202 permits a taxpayer to exclude a specified percentage of such gain, while §1045 permits a taxpayer to avoid, or at least defer, recognition of potentially all such gain if the taxpayer reinvests in qualified small business stock within sixty days.
Section 1202 permits a taxpayer, other than a corporation, to exclude in general 50% of the gain realized on the sale of such stock if the taxpayer holds the stock for more than five years prior to sale.

Section 1244 of the Internal Revenue Code, the small business stock provision, was enacted to allow shareholders of domestic small business corporations to deduct as ordinary losses, losses sustained when they dispose of their small business stock. In order to receive this beneficial treatment, the Code prescribes specific requirements for: (1) the corporation issuing the small business stock; (2) the stock itself; and (3) the shareholders of the corporation.

(1) The corporation issuing the stock must qualify as a domestic small business corporation, which generally means that it must be created under the laws of the United States and that its aggregate capital must not exceed $1,000,000 at the time the §1244 stock is issued to its shareholders. The first taxable year in which the capital of the corporation exceeds $1,000,000 is called the transitional year, and the corporation must designate which shares issued that year qualify for §1244. For example, if a newly formed corporation received $2,000,000 for its initial issue of stock, it could designate up to $1,000,000 of its stock as qualified §1244 stock.

Section 1244 is available only for losses sustained by shareholders who are individuals. Losses sustained on stock held by a corporation, trust or estate do not qualify for §1244 treatment. Subject to very limited exceptions, the benefits of §1244 are only available to individuals who acquire the stock by issuance from a domestic small business corporation, and are not available to a subsequent transferee of the stock. In some cases, a partnership can qualify as a shareholder of §1244 stock. Generally, all transfers of §1244 stock by the shareholder, whether in a taxable or nontaxable transaction, whether by death, gift, sale or exchange, terminate §1244 status.

To qualify for section 1244 treatment, the corporation, the stock and the shareholders must meet certain requirements. The corporation's aggregate capital must not have exceeded $1 million when the stock was issued and the corporation must not derive more than 50% of its income from passive investments. The shareholder must have paid for the stock and not received it as compensation, and only individual shareholders who purchase the stock directly from the company qualify for the special tax treatment. This is a simplified overview of section 1244 rules; because the rules are complex, individuals are advised to consult a tax professional for assistance with this matter.