Section 1202/1045 and Tax Evasion?

[separate899]

Is it considered tax evasion if:

In 2017, John purchases QSBS stock for $1,000 from an early stage start up. In 2019, the startup is sold to a public company and John receives $1,000,000 in cash proceeds. Within 60 days (Section 1045 rollover), John purchases $1,000,000 of QSBS stock in a C Corporation he started and is the Executive Chairman, President, etc of. The C Corporation does not have any paid employees and John uses a minimal amount of its funds to pay personal expenses.  Now, in 2024, John continues to hold the $1,000,000 in his C Corporation and it has not been spent down by the C Corp.

John claims that over the course of his holding (it’s now been 7 years) inclusive of electing the Section 1045 rollover into his own C Corporation that he’s fulfilling Section 1202 requirements. Except that it can be proven that John has just parked his money and used the C Corp as a tax shelter through the Corp’s bank account statements and financial statements.

If the C Corp’s info is presented to the IRS, has John illegally deferred and failed to pay capital gains taxes on his $999,000 gain?  

Or can it only be proven that he has failed to pay capital gains taxes after he sells his “QSB” stock from his C Corp?  

If after he sells, does the active business reqmt have to apply for the first five years? Or for the entire 7+ years?

[DaveF1006]

First of all, much of this involves a legal interpretation that we cannot render. The one red flag I can see however is that John use the rollover to purchase QSBS in a corporation he owns and not in a corporation in which he is a passive investor. Rather or not this is permissible is a legal opinion that we cannot further speculate on but is something that you may need to do legal research on or pay for legal advice.

John is correct in stating that the holding period for the stock is 7 years since he performed a qualified 1045 section rollover. The seven-year window ended in 2023, so if he sells, he can defer the gain. Again though, the issue may be this is a corporation he owns and the fact that he used some of the money for personal expenses. You may need to consult with legal counsel for further advice if this is an issue of concern.

[separate899]

To confirm, an IRS audit couldn’t even come into play to review the situation if John does not sell the QSBS in his C Corp and continues to hold?  Or would an IRS review whether requirements of Section 1202 have been met in just the first five year period?   

In other words, while John holds per Section 1045, however the reqmts of Section 1202 were not met in the first five years, would he be liable for the capital gains taxes?

[DaveF1006]

I am not certain what you are asking here. He performed a rollover in 2019 using Section 1045 rules. Section 1202 rules do not apply with this rollover because he didn't sell the stock. He just repurchased stock and reinvested in another C-Corp. 

Could you rephrase that last paragraph because I do not fully understand the question unless you were asking if the rollover was subject to Section 1202 restrictions. If this is the case, it was not.