I believe TurboTax is computing the wrong tax for a section 1202 qualified small business stock (QSBS) exemption when combined with short-term capital gain. See example.

[angel6]

How to reproduce this:

1. Start with a fresh return, single filer

2. Add a long-term capital gain sale X: bought 1/1/2000, sold 1/1/2018 for $1,000,000, basis 0

3. Add a short-term capital gain sale Y: bought 7/1/2017, sold 1/1/2018 for $50,000, basis 0

4. Add a long-term capital gain sale Z: bought 1/1/2000, sold 1/1/2018 for $1,000, basis 0

5. The tax due shows as $233,388. This is correct to my knowledge.

6. Now, for the Z $1,000 sale, select it as a qualified small business stock sale (section 1202). 50% of the gain is shown as excluded.

7. But the tax due now shows as $233,409. <-- BUG! Tax goes up after the exclusion.

Why do I think this is a bug? 50% of the gain was excluded correctly from long-term capital gains (and correctly added as 7% preference item in AMT), but in the "Schedule D tax worksheet" an extra 50% of the gain ($500) is added in to line 19, which is taxed at short-term capital gains (ordinary income) rate. So it honored the 50% exclusion but it seems to have put the other 50% into the ordinary income which I claim is wrong.

I can't think of any reason in the tax code why excluding 50% of a long-term capital gain should result in an additional short-term capital gain.

This miscalculation happens only when there are both non-QSBS long-term and short-term gains present AND when the QSBS transaction is from the 50% exclusion date range. For example, if the QSBS transaction is entered as bought 1/1/2012 then the correct 100% exclusion is applied and the tax shows as $233,143.

Version: Deluxe windows download, tax year 2018

[angel6]

I got this answer from Intuit directly.

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I believe you may have found a bug as well...but not with TurboTax 🙂

This behavior is certainly unusual, but it is consistent with the tax forms and the Internal Revenue Code. So if we want to call it a bug, then the bug lies with Congress to fix.

Here's what's happening. The key here is that the gain portion of 1202 stock is treated as a 28% gain rather than ordinary long term capital gain (see IRC 1(h)). As 28% gain stock, it’s not eligible for the 0% rate that other long term stock is at lower tax brackets. For AMT purposes (and if you look closely, you'll see the extra tax is introduced by AMT -- the regular tax does go down as expected), what's happened here is the taxpayer converted $1000 of normal long term gain to $500 of 28% gain. In this situation, some of the normal long term gain was getting the 0% tax rate that applies to long term capital gain at the lower tax brackets. But as 1202 stock, we've effectively converted $500 from long term gain that would have gotten a 0% tax rate to $500 that gets a 26% tax rate ("28% gain" just means it's taxed at ordinary tax rates, up to a maximum of 28%). Plus we've added an additional $35 of AMT preference item also gets the 26% tax rate. So we've increased AMT by $139 ($535 * .26). On the flip side, overall income has been reduced by the $500 exclusion, which means there’s $500 less long term capital gain subject to a max 20% rate. But that reduction only amounts to $100 ($500 * .20). The net effect of those two changes is a $39 increase in taxes.

So there you have it. The tax code has now gotten so complicated that in some situations tax "breaks" can unexpectedly lead to tax increases. (And there are instances that go the other way too, where items that should theoretically increase taxes actually reduce them.) And that's why you use TurboTax to stay on top of all this chaos for you 😉