The qualified small business stock exclusion (QSBS) is a tax exclusion available to certain small businesses and startups. Under the qualified small business stock exclusion, income from sales of QSBS held for at least five years is partially—or in some cases, totally— excluded from federal taxation. This benefit can be huge for stockholders investing in small businesses. If you are interested in finding out if this exclusion may apply to you, you should contact a business tax attorney from the Priori network to discuss this further.
What Is Qualified Small Business Stock?
Only holders of qualified small business stock can take advantage of this exclusion. Under federal guidelines, the following qualifications must be met for stock to be considered QSBS.
- The stock is from a domestic C-Corp (and the company has been a C-Corp for substantially all the time you have owned the stock);
- The corporation did not have more than $50 million in assets as of the date the stock was issued or immediately after;
- You acquired the stock at its original issue, not from a secondary market; and
- At least 80% of the corporation’s assets were used in the active conduct of one or more qualified businesses during substantially all the time you owned the stock.
The last point is the most complicated to define. The phrase “active conduct” is used to emphasize that the corporation can’t be an investment vehicle or inactive business. In addition, only certain types of businesses qualify for QSBS. Stock from the following types of companies are excluded:
- Hotels, motels, and other similar businesses;
- Corporations active in banking, insurance, financing, leasing, investing, or other financial services;
- Real estate companies;
- Mining and mineral extraction companies; and
- Corporations that provide professional services, such as health care, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting.
The main reason that the qualified small business stock exclusion appeals to investors is the tax benefits—which are substantial. If you’ve held stock qualifying as QSBS for at least five years when it’s sold, a portion of your gain—or in some cases all of your gain—can be excluded from federal tax. Only the remaining portion is subject to the 28 percent capital gains tax rate.
How Much QSBS Can Be Excluded?
Exactly how much QSBS can be excluded from federal taxation depends on the date upon which the qualifying stock was acquired.
- For qualifying stocks purchased before February 18, 2009, 50 percent of capital gains are excluded from taxation;
- For qualifying stocks purchased between February 18, 2009 and September 27, 2010, 75 percent of capital gains are excluded from taxation;
- For qualifying stocks purchased between September 28, 2010 and December 31, 2014, 100 percent of capital gains are excluded from taxation; and
- For qualifying stocks purchased on or after January 1, 2015, 50 percent of capital gains are excluded from taxation.
This exclusion is, however, limited. For any single investment, it can only apply to gains up to either $10 million or 10 times the taxpayer’s adjusted basis in the stock, whichever is greater (usually $10 million dollars).
The legal costs of QSBS and other tax-related issues can vary significantly based on a variety of factors. Priori lawyers can guide you through the process from approximately $150 to $375 per hour. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and free price quote from one of our lawyers.
Can I get a state-level QSBS exclusion in California?
Not anymore. California used to offer preferential treatment for QSBS under a more lax definition than the federal guidelines, but this was discontinued after the 2012 tax year. Other states do have similar programs still today, though, so you should discuss the state implications with a qualified tax attorney familiar with the jurisdiction.
Will the QSBS exclusion go back to 100 percent?
As of now, the 100 percent QSBS exclusion has not been reinstated, but many suspect that Congress may extend it again. President Obama’s has proposed making the 100 percent exclusion rule permanent in several budget proposals, but it is unclear whether or not this will ultimately pass.