Section 1202: sell your company and keep the gain tax-free

The numbers

Picture a founder who started a manufacturing company as a C corporation, held the stock for more than five years, and sells it with a $15 million gain.

For illustration purposes. Tax law may change, which may change these calculations slightly.

Personal tax on the sale (federal)

That’s a federal tax difference of about $3.57 million on the same sale. Oklahoma taxes are figured separately; Oklahoma generally starts from federal income, and we confirm the state treatment for your sale.

For stock issued after July 4, 2025, the exclusion phases in: 50% after three years, 75% after four, and 100% after five. For stock issued earlier, the full exclusion generally requires more than five years and the cap is $10 million.

How it works

1. Operate as a C corporation. The stock must be issued by a domestic C corporation. S corp stock and LLC interests taxed as a partnership don’t qualify.
2. Get your stock at original issuance. You receive the stock directly from the company, for money, property, or services, not by buying it from another shareholder.
3. Stay a qualifying small business. The company’s gross assets must be within the limit when the stock is issued ($75 million for stock issued after July 4, 2025), and most of its assets must be used in an active, qualifying business.
4. Hold the stock long enough. Five years or more for the full exclusion.
5. Sell and exclude the gain. Qualifying gain up to the cap is excluded from federal income tax.

Who it fits

• Founders of growing manufacturing, construction, technology, distribution, and other product or service companies that plan to sell.
• Owners willing to operate as a C corporation for the long run.
• Families who want to pass on stock early, since gifted stock can carry its own cap (see “Stacking the Cap”).

When it doesn’t work

• Excluded fields: health, law, accounting, consulting, financial services, brokerage, banking, insurance, farming, hotels and restaurants, and businesses whose main asset is the skill or reputation of their people, among others.
• Businesses that need to stay S corps or partnerships for other reasons.
• Owners who expect to sell within a few years, or to sell assets rather than stock.

The rules

• Cap per company. Generally the greater of $15 million (indexed after 2026) or 10 times your basis, for stock issued after July 4, 2025. Earlier stock uses a $10 million cap.
• Converting an LLC or S corp. Converting to a C corporation starts the clock. Gain built up before the conversion isn’t excluded; the value at conversion becomes your starting point (see “The $10 Million Mistake”).
• Gifts carry the holding period. Stock gifted to family members or certain trusts keeps your holding period, and each holder may have their own cap.
• Redemptions can disqualify stock. Certain buybacks by the company around the time stock is issued can taint the exclusion.

Risks and costs to weigh

• Business tax along the way. A C corporation pays its own 21% federal income tax on profits, and dividends to owners are taxed again. That trade-off has to be modeled against the exit savings.
• Qualification over years. The company has to stay qualified for most of the holding period. Changes in your business can affect it.
• Records. You’ll need documentation of how the stock was issued, the company’s assets, and its activities to support the exclusion.
• Rules change. Section 1202 was expanded by the July 2025 tax law and could change again.

How we handle it for clients

With a Cannon & Brown tax plan, we look at Section 1202 well before a sale: whether a C corporation makes sense for your business, how to set up and document the stock, how gifting could multiply the cap, and how the C corp trade-off compares with your other options. Because our technology keeps your numbers current all year, we can test this strategy against your real numbers and adjust it as your business changes.

Illustrative example. The founder and figures on this page are hypothetical, used to explain how the strategy works. They are not a client and not a promise of results. The example assumes stock issued after July 4, 2025, held more than five years, a $15 million gain, and the 20% capital gains and 3.8% net investment income tax rates. This page is educational and is not tax or legal advice for your situation; tax rules and limits change.