Qualified Small Business Stock Explained

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Professionals in the industry know qualified small business stocks (QSBS) as eligible small business shares, as described by the Internal Revenue Code. With its gross value assets at the original cost, which is not more than $50 million on or immediately after its stock issuance, a QSBS is an active domestic C corporation. When eligible individuals hold qualified small business stock, they can receive tax benefits when they meet specific criteria.

Understanding Qualified Small Business Stock

Under the Internal Revenue Code’s Section 1202, people can invest in small businesses as allowed by the federal government. Being an active domestic C corporation, the assets of QSB don’t go more than $50 million after or on the stock issuance. There are specific companies that belong to the category of a QSB. Eligible as QSB are firms in the manufacturing, wholesale, retail, and technology, while companies in the mining, farming, the financial sector, personal service, and hospitality industry are not.

After August 10, 1993, individual stock acquired from a QSB is a qualified small business stock. Exempted from eligible small businesses from the federal taxes are the capital gains under Section 1202. Some of these need to apply to claim the tax benefits of the stock being qualified:

  • About 80 percent of the issuing corporation’s assets need to be utilized to operate one or more of its qualified businesses or trades.
  • The investor must acquire the stock for about five years.
  • The investor needs to have bought the stock with property or cash or received it as a service payment.
  • The stock must not be from the secondary market and must have been acquired by the investor at its original issue.
  • Being a corporation nullifies the investor.

Tax Benefits Requirements for Qualified Small Business Stock

How long stock was held and when it was acquired will determine a QSB’s tax treatment. There is a chance of excluding 100 percent of capital gains on a qualified small business stock by the Protecting American from Tax Hikes Act. There is a cap of 10 times the stock’s adjusted basis or $10 million. As such, there will be a 28 percent capital gains tax for gains above that amount.

Also, the full exclusion of net investment income and alternative minimum tax needs holding requirements. They usually impose the AMT on people with tax exemptions and would permit them to pay disproportionately low taxes for individuals with the same income level. Meanwhile, the lower amount gets the NII tax, which is between someone’s modified adjusted gross income or NII amount more than the predetermined limit. Exclusions apply with some of the following:

  • A 50 percent QSBS capital gains exclusion acquired between August 11, 1993, and February 17, 2009. Though, subject to AMT is 7 percent of the gain.
  • A 75 percent QSBS capital gains exclusion acquired between February 18, 2009, and September 27, 2010. Though subject to AMT is 7 percent of the gain.
  • A 100 percent QSBS capital gains exclusion acquired after September 27, 2010. Applicable is a 100 percent exclusion on capital gain, which has exclusions from NII and AMT tax.