Attention business owners…have you benefited from the QSBS exclusion? Under section 1202 of the Internal Revenue Code (IRC), shareholders can qualify for a 100% exclusion of tax on capital gains on the sale or exchange of qualified stock. We have the details here.

What is QSBS?

Created in 1993, the Qualified Small Business Stock (QSBS) tax exclusion aims to encourage shareholders to invest in startups and small companies. The exclusion provides a break on capital gains tax (up to 100%) when shareholders sell or exchange qualified stock which was issued directly to the shareholder by the company.

How do you qualify for the QSBS exclusion?

To benefit from the QSBS exemption there are a few requirements you need to meet:

• You must have held your stock in the Qualified Small Business for a minimum of five years. A QSB is a domestic C corporation with:
  • less than $50 million in assets at all times until the stock issuance
  • at least 80% of assets dedicated to actively running the business (not for investment purposes)
  • only certain businesses qualify as a QSB (for example, not a service company)
• You must understand when and how you acquired the stock. Ownership via a passthrough entity (partnership or S Corp) will be fine.

How much can the exclusion save you?

Here is a helpful table to show how much you can save based on when you secured the shares:

How is the exclusion taxed?

Under Internal Revenue Code Sec. 1202, capital gains from qualified small business stock (QSBS) are excludable from gross income. You may be able to exclude up to $10 million of capital gains or 10 times your cost basis, whichever is higher. That means you avoid the 20% long-term capital gains tax, plus the 3.8% net investment income tax. Any excess gains beyond that amount will be taxed at regular long term capital gains rates. Stock acquired after September 27, 2010, is eligible for 100% gain exclusion. Most states allow a similar exclusion.

What if you don’t meet the 5 year holding period requirement?

At times an investment in a startup may do so well that a sale takes place before the end of the 5 year holding period. While this won’t qualify for the QSBS exclusion, not all is lost. Internal Revenue Code Sec. 1045 allows a deferral of the tax on the gain as long as the original QSBS stock was held for at least 6 months and the proceeds are reinvested in a new QSBS within 60 days. The deferral requires a special election on your tax return.

Questions? Contact us.