Tax-Advantaged Qualified Small Business Stock

According to Public Law Number 117-154 (06/23/2022), the U.S. Tax Code is 6,871 pages. When you add the federal tax regulations and official tax guidance, the number of pages increases to approximately 75,000. Some very helpful tax breaks can get lost in the shuffle!

One of the lesser known tax provisions is IRC Section 1202, regarding qualified small business stock. Taxpayers who are either starting a small business or investing in one should be aware of the potential tax savings in this provision, as it reduces capital gains when stock is sold.
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What is QSBS?
The following requirements must be met for stock to be considered QSBS:

• Only stock in a qualified small business organized as a C corporation qualifies for QSBS treatment. This means the company's gross assets at the time of the stock issuance and immediately thereafter cannot exceed $50 million.
• The stock must be held for at least five years before it is sold.
• Qualifying shares must have been acquired in an original issuance from the corporation, acquired as a gift from another individual or acquired through inheritance.
• At least 80% of the corporation's assets must be used in the active conduct of one or more qualified trades or businesses during the period the stock is held.
• The business may not be engaged in banking, leasing, insurance, financing, investing, hotels, restaurants, oil and gas, or farming; be a personal service business in the fields of health, law, architecture, engineering, accounting, actuarial science, consulting, brokerage services, financial services, athletics or performing arts; or be a business whose principal asset is the reputation or skill of one or more of its employees.

Tax benefits of QSBS
In general, owners of QSBS stock who acquired that stock after Sept. 27, 2010, and sold it more than five years after acquiring it can exclude 100% of their capital gain from the sale. The gain is also exempt from the alternative minimum tax. (Stock acquired before that date is subject to different exclusion amounts and may also be subject to the AMT.)

The amount of excludable gain is capped at the greater of 10 times the individual's cost basis in the stock or $10 million. Any earnings above that amount are taxed at the ordinary capital gains rate.

The QSBS tax break may change
While these are the rules that currently apply, the law may change. For example, recently there has been some debate in Congress about how and whether to change IRC Section 1202. Not surprisingly in the current political climate, the parties have differing views: The Democrats want to put an income limit on the 100% exclusion, and the Republicans want to expand it to include S corporations.
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While it is unlikely that there will be any changes before the 2024 presidential election, this might be an ideal time to speak with a tax adviser.

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