Andersen Global
Qualified Small Business Stock (QSBS) FAQ
What is QSBS?
The QSBS provisions were enacted into law in 1993. Below is an excerpt from the committee reports that resulted in the enactment of the QSBS provisions:
The committee believes that targeted relief for investors who risk their funds in new ventures, small businesses, and specialized small business investment companies will encourage investments in these enterprises. This should encourage the flow of capital to small businesses, many of which have difficulty attracting equity financing.
Thus, the QSBS provisions were enacted to incentivize investors to invest capital in small businesses with the hopes that the success of these businesses would create jobs and spur the economy.
What are the benefits of QSBS?
The primary benefit of QSBS is the potential to partially or fully exclude up to $10 million in gains from the sale of QSBS from taxation. This is referred to as the QSBS Exclusion. In addition, the QSBS provisions provide an opportunity to roll-over gains from the sale of QSBS, similar to Sec. 1031 with real estate.
What are requirements to be considered QSBS?
The following are the general requirements to be considered QSBS:
- Company is a domestic C corporation
- Stock is originally issued by the company
- At the time of acquisition, gross assets on the balance sheet are under $50 million
- Company meets the active business requirements of Sec. 1202(e)
- Company is considered to be a qualified business under Sec. 1202(e)(3)
What is a qualified business under the QSBS provisions?
The QSBS rules define what a qualified business is by stating which businesses do not qualify, and therefore, any unnamed businesses would qualify. The types of businesses that don’t qualify tend to be service-oriented companies, such as hotels, motels, restaurants, accounting, legal, and consulting firms. While this approach may seem straightforward, there is some confusion as to what types of companies qualify, and we have seen many situations where companies believe they do not meet the definition of a qualified business but may in fact qualify for this provision. Keep in mind these rules were written in a world where email and the internet did not exist on the broad scale that they do today. Our firm can be helpful in assisting founders and early employees of companies to conclude on this matter.
What is an example of the economics of the QSBS exclusion?
Example:
California taxpayer sells $10 million worth of founder’s stock with zero basis after holding for more than five years:
Federal tax without QSBS = approximately $2,380,000 (long-term capital gain rate = 20%, affordable care act excise tax = 3.8%)
Federal tax with QSBS = none
Note: After the 2012 tax year, California no longer allows the QSBS provisions. However, many other states do allow the QSBS provisions.