Your Qualified Small Business Stock Questions Answered

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Many business owners who exit their companies experience liquidity events, sometimes these can be substantial creating multi-generational wealth.  For entrepreneurs and those advising them, understanding the nuances of their business exit is crucial, remember the devil is always in the details.  One savvy technique is Qualified Small Business Stock (QSBS), this can make a significant difference in their financial strategy.  Let’s delve into the exciting world of QSBS, below I will outline the benefits and why it should be on your radar.

What is QSBS?

Qualified Small Business Stock (QSBS) refers to shares in a corporation that meets specific requirements set by the IRS under Section 1202 of the Internal Revenue Code. This designation is not just a label; it’s a gateway to substantial tax benefits for investors who hold stock in certain small businesses.

Criteria for Eligibility of QSBS:

To qualify as QSBS, the stock must adhere to various requirements:

Must be a C Corporation:

  • The issuing company must be a U.S.-based C Corporation.

Original Issue Stock:

  • Investors must acquire the stock at the original issuance.

Active Business Requirement:

  • At least 80% of the company’s assets must be used in the active businesses.

Gross Assets:

  • The corporation’s gross assets must not exceed $50 million before and immediately after the stock issuance.

Tax Advantages of QSBS

The main benefit QSBS lies in tax benefits, and these are substantial as they are designed to encourage people to invest in small businesses and startups.

Capital Gains Exclusion:

  • Capital gains from the sale of QSBS receive and exclusion of tax exposure, however, you must ensure these shares are held for more than five years,
  • Additionally, this exclusion is capped at the greater of $10 million or 10 times the adjusted basis of the stock.

AMT and NIIT Exemption:

  • The excluded gain is NOT considered a preference item for (AMT) purposes, and it’s also exempt from the 3.8% Net Investment Income Tax (NIIT).

Rollover Provision:

  • Under Section 1045 of the Internal Revenue Code, if QSBS is sold before the five-year mark, the capital gains can be rolled over tax-free into another QSBS within 60 days of the sale.

Conclusion

Keep abreast of legislative changes that may impact QSBS qualifications and benefits.  QSBS and exit planning in general can be complex and require creative advanced planning strategies to ensure you have a successful and tax efficient business exit.  Consulting with professional advisors who are well versed in these areas is critical in navigating the QSBS landscape.  QSBS is an advanced strategy and requires a blend of strategic foresight, patience, and awareness of evolving tax legislation. As with any major financial decision, be sure to consult with trusted financial experts who understand how QSBS works and if it fits your financial plan.
This article is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax legal advisor.

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