The Qualified Small Business Stock is an Often-Overlooked Tax Windfall – Do You Qualify?

Qualified Small Business Stock

Under Section 1202 of the US tax code, there is an opportunity for non-corporate founders and investors in certain emerging growth companies to exclude up to 100% of the gain realized from the sale of a qualified small business stock (QSBS). This is a big reason for venture capitalists, angel investors, and entrepreneurs to smile

The code allows a shareholder to exclude a percentage of the gain recognized on the sale of a QSBS held for more than five years, capped at the greater of $10 million or ten times its initial investment. If the QSBS is not held for more than five years but has been held for at least six months, Section 1045 of the US tax code generally permits a tax-free rollover of gain on the sale of the QSBS if the proceeds are reinvested within 60 days of the sale. This is meant to encourage investment in certain small, active, operating businesses.

Requirements

The stock of a small business may qualify if specific criteria are met, including:

  • The stock is issued to a non-corporate stockholder (individual or pass-through, including an LLC taxed as a partnership or S-corporation)
  • The small business is a domestic eligible C corporation at the time the stock is issued
  • The stock is acquired directly from the small business at its “original issuance” in exchange for money or other property (not including stock) or as compensation for services
  • During substantially all of the time the stockholder holds the stock, the small business is engaged in a qualified trade or business and uses 80 percent of its assets to conduct one or more qualified trades or businesses
  • The aggregate gross assets of the small business from inception to the date the stock is issued (including proceeds received in exchange for the stock) is $50 million or less
  • With certain minor exceptions, the small business has not made any stock repurchases within the two years starting one year before the date the stock was issued
  • The small business has not repurchased any stock from the taxpayer claiming the QSBS gain exclusion or related parties within the four years starting two years before the date the stock was issued.

Benefits

Gain from the sale of the QSBS is eligible for 100% exclusion from US federal capital gains tax and a corresponding 100% exclusion from the alternative minimum tax (AMT), and 100% exclusion from the 3.8% net investment income tax (NIIT).

Section 1202 provides a lower percentage of exclusion (generally 50% or 75%) for QSBS issued before September 28, 2010.

Federal Exclusion of Gain
Acquisition PeriodPercent Exclusion (Regular Tax)
Before February 18, 200950
February 18, 2009–September 27, 201075
September 28, 2010, and later100

This is a complicated issue but worth investigating whether you qualify. If you have any questions or need help, please email Allan RooneyTim DavisElannie Damianos, or Abbey Docherty or call +1 212 545 8022.

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 This article is one of a series intended to de-mystify common legal issues for the non-lawyer and entrepreneur audience – they are designed to foster discussion and is by no means exhaustive. These materials are for informational purposes only. Nothing herein is intended nor should be regarded as legal advice. The distribution of this article to any person does not establish an attorney-client relationship with our firm. Rooney Nimmo assumes no liability in connection with the use of this publication. This bulletin is considered attorney advertising under the applicable rules of New York state. Rooney Nimmo UK is regulated by the Law Society of Scotland and Rooney Nimmo US by the New York rules of professional conduct. All attorneys and solicitors listed in this firm stipulate their jurisdictional limitations. Rooney Nimmo in the USA is a law firm registered as a New York State professional corporation.

 

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