How to Save Millions with Qualified Small Business Stock
Posted on Mon, Aug 01, 2011 @ 02:50 PM
by Laura Barooshian, CPA, MST and Joel Rothenberg, CPA
In the right situation and with proper planning, business owners and private investors may be able to exclude up to $10 million in capital gains when they sell “qualified small business stock”(QSBS). Under normal circumstances, appreciated securities that have been held for over one year and sold at a gain are taxed at 15% for federal purposes. Internal Revenue Code (IRC) Section 1202 allows an individual taxpayer to exclude capital gains on the sale of QSBS from tax if certain criteria are met.
This exclusion has been available since 1993, however, a portion of the gain had been subject to the Alternative Minimum Tax (AMT) regime. As a result, taxpayers who were subject to the AMT, realized minimal federal tax benefit.
A new “twist” on the existing QSBS law, which went into effect on September 27, 2010, creates an enhanced federal tax benefit. The new law applies to any "new stock" issued before January 1, 2012, subject to the restrictions outlined below. When the "new stock" is eventually sold, up to $10 million of gain will be excludable for both regular tax and AMT purposes (50% for Massachusetts purposes).
In order for the stock to be considered QSBS, the company must:
- Be organized as a C corporation,
- Own total assets (from inception until the time of stock issuance) with an adjusted basis of $50 million or less,
- Operate in a qualifying industry (some businesses, such as service businesses, do not qualify), and
- Use at least 80% of the value of the corporation’s assets to conduct its qualified business.
(Please note, this list is not all inclusive and the requirements are very complex. Given the potential significant tax savings available, we recommend that you contact DGC before moving ahead with any investment.)
In addition, the shareholder must have held the stock for at least 5 years from the date of issuance through the date of sale. For stock issued in 2011, that would translate to an eventual sale in 2016 or later, after the 5-year holding period has been met.
Time is of the essence as the 100% gain exclusion is set to expire on January 1, 2012.
While QSBS issued prior to September 27, 2010 does not qualify for the newly enhanced federal tax benefit, it still qualifies for the 50% Massachusetts capital gain exclusion. So, it also makes sense to assess whether you may own QSBS that was acquired prior to such date.
QSBS investments made via partnerships or LLC may also qualify for the tax benefits described above making this particularly attractive for private equity and venture capital funds.
To determine if your business or a business you have invested in qualifies for the old or new exclusion, talk to your DGC advisor.