A post-transaction Section 1202 analysis uncovers a critical defect — and turns a near-total loss of QSBS benefits into a multimillion-dollar tax win.
Background
Section 1202 of the Internal Revenue Code allows eligible shareholders of Qualified Small Business Stock (QSBS) to exclude up to 100% of capital gains from federal income tax — often representing millions in potential savings. Despite its value, the provision is frequently overlooked or misunderstood.
In this case, a business owner sold his California-based insurance company to a private equity buyer in mid-2024. He believed his shares qualified for the Section 1202 exclusion, but neither the transaction advisors nor the original deal documentation reflected a clear or defensible QSBS position.
The client came to MGO after his longtime tax preparer flagged Section 1202 as a potential opportunity and referred him to an MGO article explaining how the statute works.
Challenge
The client believed he and his spouse collectively owned more than 600,000 shares issued over several decades — well within the parameters needed to support a Section 1202 claim. However, MGO’s review of the stock purchase agreement, corporate records, and articles of incorporation revealed a serious issue:
- The corporation was authorized to issue only 1,000 shares.
- The stock purchase agreement reflected a sale of just 500 shares.
- Additional shares allegedly issued in prior years had never been properly authorized through amended articles of incorporation.
In short, the shares the client believed qualified for Section 1202 technically did not exist under California corporate law. Without correction, the gain exclusion would have been unavailable — exposing the client to millions in unexpected tax liability more than a year after the sale closed.
Complicating matters further:
- The client had no longstanding corporate counsel.
- The buyer’s attorneys had already finalized the transaction.
- The tax return filing deadline was weeks away.
Approach
MGO coordinated a multidisciplinary response that brought together tax, legal, and transactional professionals. Working with experienced California corporate counsel, the team identified a statutory remedy that allowed defective corporate acts to be retroactively ratified — effectively validating the historical issuance of shares that had never been properly authorized.
MGO then:
- Led a detailed Section 1202 eligibility analysis — including holding periods, issuance dates, and asset thresholds
- Worked with legal counsel to retroactively ratify the stock issuances under California law
- Collaborated directly with the private equity buyer’s attorneys to amend the stock purchase agreement so it aligned with the corrected capitalization history
- Prepared robust Section 1202 documentation, including formal shareholder representations critical for audit defense
Despite initial resistance, all parties reached agreement in a compressed three-week window — allowing the corrected structure to be finalized before the client’s tax filing deadline.
Value to Client
MGO’s intervention converted a failed Section 1202 position into a substantial financial result:
- Nearly $2.4 million in federal tax savings preserved
- Full validation of QSBS eligibility across 600,000 shares
- Transaction documentation aligned with tax reality — reducing audit exposure
What initially appeared to be an irreversible post-closing issue became a successful recovery — highlighting the importance of deep Section 1202 knowledge, rigorous documentation, and proactive coordination across advisors.
Why Section 1202 Planning Can’t Wait
This case underscores a broader lesson: Section 1202 benefits don’t materialize automatically. They depend on accurate corporate records, disciplined planning, and careful analysis — ideally well before a liquidity event.
Explore Your Section 1202 Position
MGO works with founders, investors, and growing companies to evaluate Section 1202 eligibility, remediate documentation gaps, and prepare defensible positions for audits or exits.
If you’ve issued stock, or are planning a sale, now is the time to understand what Section 1202 could mean for you.