What is the QSBS Exclusion?
The qualified small business stock (QSBS) exclusion is something that has been a part of tax law for over 25 years, and became permanent in 2015 as a part of the PATH (Protecting Americans from Tax Hikes) Act. It is designed to encourage investment in small businesses, by permitting gain exclusion for the sale of qualified small business stock.
In order to benefit from the QSBS exclusion, it is imperative to understand the rules and qualifications for this complex tax code. We have compiled 6 rules to follow to get your started, and as always we are here to help provide further planning and advice when you need it.
6 Rules for the QSBS Exclusion
#1: The stock must be issued by a qualified domestic corporation
To be eligible for the QSBS exclusion, the business must be a domestic C corporation. Most major U.S. corporations and venture capital-backed start-up companies are organized as C corporations.
“Any shares you have in the qualified business must be original issue shares, meaning you have acquired them directly from the corporation either through purchase or receiving them from the company as compensation. Shares bought on a secondary market or from another person who acquired them directly from the company will not qualify for the QSBS exclusion.” – Pro Tip by Amar Realtor – San Jose Real Estate Agent
#2: The company must be “small”
In order to qualify, the gross assets of the company must be $50 million or less at all times before, and immediately after, the company issues stock. In order to avoid inventing a company as an investment vehicle, the company must be an active business, defined as one with 80% or more of its assets used in a qualified trade or business.
#3: The company must not be a part of any excluded industries
To be considered a company in a qualified trade or business, the corporation must not be a part of a list of excluded industries, including:
- Health
- Law
- Engineering
- Architecture
- Accounting
- Consulting
- Performing Arts
- Athletics
- Hospitality
- Farming
- Banking
- Finance
- Mining
Most tech companies will qualify, and there are plenty of others as well. If you are concerned about the qualifications, speak with the company’s CFO or finance team.
#4: You must hold on to the stock for at least five years
From the time you receive your shares, you have five years before you are eligible for the QSBS exclusion. This does not include stock options. If you received stock options, the five year counter does not begin until the date that you purchase shares from the company.
Be sure you understand the distinction between stock and stock options. A misunderstanding of this crucial component can cost you a lot.
#5: You can exclude up to $10 million in gain
Up to $10 million of gain can be excluded from income tax for a married couple filing a joint tax return, so being sure you follow the rules for the QSBS exclusion may be one of the most important tax codes for you. Making sure you are following the five year rule and dealing with a qualified domestic C corporation will pay off at tax time.
The amount of taxable gain you can exclude from you taxable income is limited to the greater of the following two:
- An aggregate per taxpayer of $10 million
- 10 times the cost basis of shares sold in the tax year
The cost basis is what you paid for the shares. In most cases, you cost basis will be the lower of the two numbers.
#6: Only stock acquired during certain time periods will qualify
There are a few relevant rules for the timing of your stock acquisition:
- The 100% gain exclusion only applies to stock acquired after September 27, 2010
- Stocks acquired between February 18, 2009 and September 26, 2010 will be 75% exempt
- Stocks acquire between August 11, 1993 and February 17, 2009 will be 50% exempt
- No exclusion is available for stocks acquired before August 11, 1993
