QSBS Exemption: How to Reap Big Tax Benefits for Your Small Business
October 5, 2021
At a glance
- The main takeaway: The qualified small business stock (QSBS) exemption is a lucrative tax opportunity for eligible small businesses and those who invest in them.
- What’s in it for you: If you qualify, you can reap up to $10 million in federal tax savings by taking advantage of the QSBS exemption.
- Next steps: Aprio’s Tax team can help you assess your eligibility, navigate potential challenges and complexities, and leverage the credit to help you reap the greatest tax savings.
The full story:
What if you could save up to $10 million on your federal taxes?
You may be thinking that a tax provision as generous as this is wishful thinking. But in fact, it’s not — this cash benefit is made possible with the qualified small business stock (QSBS) exemption.
Implemented as part of the tax code in 1993 (under Section 1202 of the Internal Revenue Code), this rule initially allowed for a partial gain exclusion on the sale of QSBS, with the goal of mitigating risk and granting relief to those who invested in startups, small businesses and new ventures.
The exemption became more attractive in 2010 with the enactment of the Small Business Jobs Act (SBJA). The SBJA amended Section 1202 to exclude 100% of the gains from the disposition of QSBS acquired after September 27, 2010, and before January 1, 2011 — effectively eliminating the federal tax on qualifying QSBS sales.
Three positive outcomes from taking the QSBS exemption
The QSBS exemption crept back into the limelight in late May when the U.S. Department of the Treasury released President Biden’s proposed changes to the Internal Revenue Code. Though the administration has proposed other changes that may affect business owners, it looks like the Section 1202, and thus the QSBS exemption, provisions will remain untouched. What’s more, the IRS also released a private letter ruling stating that shares of fintech companies can take part in QSBS, which has been a growing and emerging market since the onset of the pandemic.
The renewed focus on small business tax provisions is a good reminder to take advantage of all the QSBS exemption has to offer. The most appealing benefits are as follows:
- You can potentially exclude the higher of $10 million in capital gains or 10 times your cost basis from your federal tax bill.
- You may be able to receive tax-free treatment from the state in which you reside, pending a few key criteria. For instance, you would need to establish residency in a state that has no income or capital gains tax or conforms to the federal QSBS tax treatment. The key is that you must be a resident of the state that conforms to QSBS treatment at the time of the sale.
- You may be able to gift your qualifying QSBS to another taxpayer to reap even more tax benefits. Under the provisions of Section 1202, a taxpayer holding qualifying stock can gift that stock, enabling them to reap the benefits of QSBS upon sale. The gift could be made to an individual, such as a child or grandchild, or to a grantor trust intended for a child, grandchild or other relative.
Qualifying for the QSBS exemption
Before you can reap the benefits of the QSBS exemption, you need to make sure you qualify. The eligibility criteria are as follows:
- The QSBS shares that you hold must be the original issuance in order to qualify. The shares must be acquired from a C corporation or an underwriter after 1993 (when the exemption was initially put into place) in exchange for products, services or monetary assets.
- You must meet the timing requirements. In order to qualify for the exemption, you must hold the shares for more than five years under Section 1202.
- The shares must be associated with an active business. You can only take advantage of the QSBS exemption if at least 80% of the shares are connected with an active business or trade activity.
- You must meet the gross asset threshold. Since the QSBS exemption was specifically designed to encourage investment in small or startup business ventures, the company through which your shares are associated must have no more than $50 million in gross assets to qualify.
The bottom line
There are other financial planning and tax complexities associated with the QSBS exemption, which is why it’s important to have an integrated team of tax and financial professionals working in your corner to ensure you make the most of the opportunity.
Aprio’s Business Tax team brings the deep and comprehensive expertise you need to navigate the QSBS exemption, from determining eligibility to assessing which benefits are available to you, as well as any potential challenges that may come with them.
Schedule a free consultation with our team today to learn more.
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About the Author
Mitchell is the partner-in-charge of Aprio’s Tax practice as well as the Technology & Biosciences group. He has been a partner since 1990 with Aprio, which is the largest Georgia-based tax, accounting and consulting firm. Mitchell works with companies in the software, gaming, clean tech, financial technology (FinTech), health care IT, processing, biosciences (biotech and medical device) and manufacturing industries. Whether a company is pre-revenue, starting up, growing or preparing for a liquidity event, Mitchell works with them to maximize their potential at each stage. He is known for promoting research, innovation and entrepreneurship by enabling companies to be successful, regardless of where they are in their business lifecycle.