If you’re a small business owner, you may have heard of something called “QSBS.” But what is QSBS, and why should you care? Keep reading to learn everything you need about this important tax benefit.
What is QSBS?
QSBS stands for “Qualified Small Business Stock.” It’s a designation given to certain stock that meets specific criteria set forth by the IRS. To be eligible, the stock must be issued by a C corporation that fulfills the following criteria:
The corporation must be engaged in a qualified trade or business.
A corporation seeking to take advantage of the QSBS provisions must first demonstrate that it is engaged in a qualified trade or business. This requirement is meant to ensure that the tax benefits connected with QSBS are only available to legitimate businesses and not holding corporations or other organizations with a primary financial purpose. To be considered a qualified trade or business, an entity must be engaged in an active and ongoing business operation with a reasonable expectation of profit. This definition typically excludes businesses that are involved in speculative activities or those that are considered hobbies. A corporation may be eligible for certain tax benefits under the QSBS provisions if it can meet this initial threshold.
The corporation cannot have more than $50 million in assets.
A corporation is only eligible for the QSBS tax deduction if it meets certain requirements. One of these requirements is that the corporation cannot have more than $50 million in assets. This asset limit includes both physical assets and intangible assets such as patents and copyrights. This requirement ensures that only small businesses with limited capital can benefit from the QSBS deduction. In addition, the corporation must be engaged in a qualified business activity, such as manufacturing or research and development. The QSBS deduction can be a valuable tool for small businesses, but it is important to ensure that all requirements are met to qualify. Speak with a tax advisor to ensure your business qualifies for the deduction.
At least 80% of the corporation’s assets must be used in the active conduct of a qualified trade or business.
The Qualified Small Business Stock (QSBS) exclusion enables non-corporate investors to completely exclude the gain on the sale of specific small business stocks held for more than five years. To qualify, the stock must be acquired: 1) at original issuance, in exchange for money, property (other than stock), or as payment for services; 2) from an existing shareholder by gift or inheritance; or 3) in a qualified exchange. In addition, the corporation must be a C-corporation for the purposes of federal income tax, and at least 80% of its assets must be employed in the active conduct of a qualifying trade or business. The QSBS exclusion can provide significant tax savings for eligible taxpayers. It can be an especially powerful tool for growing businesses when coupled with lower corporate tax rates.
The stock must have been originally issued after August 10, 1993.
The stock’s initial issuance date must have been after August 10, 1993, in order to be eligible for the QSBS tax exemption. There are a few exceptions to this rule, but generally speaking, the stock must have been issued within the last 25 years to qualify. This requirement ensures that only newly formed businesses can take advantage of the tax break intended to incentivize investment in young companies. While the QSBS requirements can be somewhat complex, they offer a valuable tax benefit for investors in qualifying companies. As such, consulting with a tax professional is important to ensure you take advantage of all available opportunities.
The stock must have been purchased at its original issue price.
There are a few reasons for this requirement. First, it ensures that only genuine small businesses are taking advantage of the exclusion. Second, it helps to prevent abuse of the exclusion by preventing investors from simply buying up QSBS on the secondary market and then selling it later at a profit.
Of course, there are a few exceptions to this rule. For example, if a larger company buys out a small business, the QSBS shares may be transferred to the new owner without losing their status as QSBS. However, these are relatively rare cases. In most situations, you’ll need to purchase QSBS directly from the issuing company in order to take advantage of the exclusion.
The stock cannot have been acquired through an exchange or merger.
The corporation cannot be a publicly traded corporation or a partnership.
You must have owned the stock for more than five years before it is sold. Gain or loss on the sale is treated as long-term capital gains or losses.
The stock cannot have been acquired through an exchange or merger. The basis of the new shares is generally equal to the adjusted basis of the exchanged property. You generally cannot exclude gain on that part of your investment acquired through an exchange or merger after August 10, 1993. The nature and extent of these restrictions are too complex to discuss here. You should get professional help if these rules apply to you.
If your company’s stock meets all of these requirements, you may enjoy some significant tax benefits if you sell it. Specifically, you may be eligible for a permanent exclusion from capital gains taxes on the sale of your QSBS shares. That means more money in your pocket!
If you sell your QSBS, you may be eligible for what’s known as the “QSBS Gain Exclusion.” You can exclude up to 100% of your taxable gain with this exclusion. That means if you sell your QSBS for $100,000 and your cost basis (what you paid for it) is $10,000, your taxable gain would be $90,000. However, if you qualify for the full 100% exclusion, your taxable gain would be zero!
You’ll need to file Form 8949 with your tax return to claim the exclusion. Be sure to keep good records of your purchase price and date to accurately calculate your gain (or loss) when it comes time to sell.
If you’re a small business owner, it’s important to be aware of the potential tax benefits available to you. One such benefit is QSBS or “Qualified Small Business Stock.” If you think your company’s stock may qualify, speak with a tax professional to see if you can take advantage of this valuable tax break.
