The §1202 QSBS MSO Diligence Checklist

INSTITUTIONAL CHECKLIST · §1202 QSBS PLANNING

A transaction-time diligence checklist for evaluating potential §1202 qualified small business stock positions in a C-corporation MSO context, including 2025 OBBBA framework.

By Alex Jones, EA, CFP®, CLU®, ChFC®, CEPA, Co-Founder, Guardian Tax Consultants®.

How to use this checklist

Section 1202 exclusion is claimed and tested at the triggering transaction, against issuance-date and holding-period facts fixed earlier, (typically a stock sale or qualifying redemption). This checklist surfaces the diligence questions a deal team, tax counsel, and CPA firm should answer well before transaction time to preserve the position and to give counsel a clean record to opine on. It is a diligence tool, not a tax opinion.

1. Original issuance

• ☐ Stock acquired directly from the corporation (not on a secondary market).
• ☐ Acquisition for money, property other than stock, or services.
• ☐ Issuance date and consideration documented in the corporate record.
• ☐ Stock certificate or book-entry record preserved.
• ☐ No prior secondary transfer that would break original-issuance treatment.

2. Gross assets ($75M post-OBBBA)

• ☐ Aggregate gross assets at and immediately after issuance verified against the applicable threshold: $50 million for stock issued on or before July 4, 2025; $75 million for stock issued after July 4, 2025 (indexed after 2026).
• ☐ Asset roll-up across the controlled group performed correctly.
• ☐ Pre-issuance asset transfers reviewed for taint.
• ☐ Subsequent gross-asset growth tracked for purposes of later issuances.
• ☐ Workpapers preserved for transaction-time verification.

3. Active business test

• ☐ At least 80% of corporate assets used in the active conduct of a qualified trade or business.
• ☐ Working capital and investment-asset positions reviewed for the active-business limitations.
• ☐ Real-estate holdings reviewed for active-conduct treatment.
• ☐ Active business test re-tested across the relevant holding period.
• ☐ Annual documentation of asset-use composition.

4. Qualified trade or business under §1202(e)(3)

• ☐ Confirm the trade or business is not on the §1202(e)(3) exclusion list (health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage, banking, insurance, financing, leasing, investing, farming, mineral extraction, hotels, motels and restaurants, and any business whose principal asset is the reputation or skill of employees).
• ☐ For potentially excluded categories, document the principal-activity analysis.
• ☐ For mixed-activity businesses, document the asset-use and revenue-mix analysis.
• ☐ Counsel sign-off on the qualified-business determination.
• ☐ Re-test on material business changes.

5. Redemption taint under §1202(c)(3)

• ☐ Identify all redemptions of corporate stock in the lookback windows: 2 years before/after issuance (taxpayer and related persons) and 1 year before/after (redemptions over 5% of value).
• ☐ Apply the de minimis and significant redemption rules.
• ☐ Apply related-party redemption rules with care.
• ☐ Document analysis of any potentially tainting redemptions.
• ☐ Coordinate with counsel before executing any redemption during the relevant windows.

6. Holding period (3/4/5-year tiers post-OBBBA)

• ☐ Confirm acquisition date for each holder.
• ☐ Track holding period against the post-OBBBA 3-year, 4-year, and 5-year exclusion tiers. Stock acquired on or before July 4, 2025 remains on the five-year, 100%-or-nothing rule.
• ☐ Per-issuer cap computed for each holder: greater of $10M (stock acquired on or before July 4, 2025) or $15M (acquired after; indexed after 2026), reduced by prior-year exclusions, or 10× basis; one-half for married filing separately.
• ☐ Non-excluded gain at the 3- and 4-year tiers modeled at the 28% rate plus NIIT.
• ☐ Document tacking rules for gifts, transfers at death, and partnership distributions where applicable.
• ☐ Plan transaction timing around the relevant tier thresholds.
• ☐ Refresh the holding-period schedule at each transaction trigger.

7. State conformity

• ☐ Identify the state of residence of each shareholder.
• ☐ Confirm state conformity to federal §1202 (full conformity, partial conformity, or non-conformity).
• ☐ Model state-tax impact assuming non-conformity in the relevant residence states.
• ☐ Review any residency-change planning with counsel.
• ☐ Document the state-tax analysis in the transaction file.

8. Transaction structure (stock sale vs asset sale)

• ☐ Confirm the transaction is structured as a stock sale to qualifying shareholders, or analyze alternative structures (e.g., installment sale, partial sale).
• ☐ Identify buyer preference and negotiating posture.
• ☐ If the buyer requires an asset deal, evaluate a sale followed by complete liquidation under §331 (Form 966 within 30 days after the plan is adopted).
• ☐ Document the structure rationale and any concessions made to preserve §1202 treatment.
• ☐ Coordinate §1202 positioning with any §338(h)(10), §336(e), or other elections under consideration.
• ☐ Final counsel sign-off prior to closing.

9. QSBS file and audit readiness

• ☐ Maintain a contemporaneous QSBS file from issuance: cap table and subscription records, gross-asset schedule at issuance, periodic support for the 80% active-business requirement throughout the holding period (with additional testing when significant asset, financing or business changes occur), MSA and invoices showing operational deliverables, redemption analysis, and basis support for each holder.
• ☐ Refresh the file annually, and before any financing or transaction.
• ☐ Obtain an updated counsel memo on the §1202 position before a sale.
• ☐ Keep the file in a form a reviewer or examiner can follow without reconstruction.

Disclosures

This checklist is published by Guardian Tax Consultants® for educational and diligence purposes. It is not a tax opinion, legal opinion, or financial-product recommendation, and it does not establish an advisor-client relationship. Specific facts, applicable state law, and the federal tax code in effect at the relevant time will govern any actual planning. CPA firms, tax counsel, and family-office advisors should review each item with qualified professionals before relying on it. Past results do not guarantee future outcomes.