Abby owned AB Inc. and Charlie owned CD Inc., both qualifying §1202 businesses with their stock qualifying as §1202 stock. After merging AB Inc. and CD Inc. under state law (assume the transaction meets the technical requirements of §368(a)(1)(A), with AB Inc. being the surviving corporation), Abby and Charlie met with their tax professional. The tax professional determined that the maximum §1202 benefit for Charlie as of the date of the merger was $1,000,000, and the gross assets of AB Inc. immediately after the merger now exceeded $75,000,000 (see our article from October 24, 2025, titled “The OBBBA Impact on the §1202 Aggregate Gross Asset Limitation”).

The general rule under §1202(c)(1)(B)(i) is that stock received in exchange for other stock does not qualify as §1202 stock. This rule is overridden by §1202(h)(4)(A), which allows stock received by a shareholder in a §368 reorganization or §351 transaction still to qualify for the §1202 benefit notwithstanding the prohibition contained in §1202(c)(1)(B)(i). However, if the stock so received is not itself eligible §1202 stock, §1202(h)(4)(B) freezes the maximum §1202 benefit that the shareholder exchanging the §1202 stock in the §368 reorganization or §351 transaction can receive upon the eventual disposition of the new stock received. The maximum §1202 benefit is frozen at the amount of §1202 gain exclusion that would have been available at the time of the §368 reorganization or §351 transaction.

Absent the exception found in §1202(h)(4)(A), Charlie’s exchange of CD Inc. stock for AB Inc. stock in the §368 reorganization would disqualify the AB Inc. stock received by Charlie in the merger from §1202 treatment, as AB Inc.’s gross assets immediately post-merger exceeded the $75,000,000 gross asset cap. Although, the §1202(h)(4)(A) exception applies to keep Charlie’s newly received AB Inc. stock §1202-eligible, §1202(h)(4)(B) restricts the maximum exclusion benefit available to Charlie upon the future sale of his AB Inc. stock, effectively limiting his qualifying gain exclusion to the frozen $1,000,000 exclusion amount and, thus, preventing any future appreciation in AB Inc. from qualifying for the §1202 benefit.

Assuming all the other §1202 requirements were met, if, however, the aggregate gross assets of AB Inc. immediately after the merger did not exceed $75,000,000, the §1202 benefit would not be subject to §1202(h)(4)(B) and Charlie’s §1202 benefit would not be frozen as of the time of the merger. Rather, the §1202 benefit would continue to grow for the AB Inc. stock owned by Charlie.

These transactions are complex and involve many nuances that cannot be fully addressed in a brief blog post. The above discussion will be among a plethora of topics discussed at this year’s Tax Planning Forum® programs, which are in full swing. Register now for one of the six remaining sessions available this season!