What is qualified small business stock (QSBS)?
Takeaway: QSBS can be a substantial tax break for founders and early investors so long as the conditions are met. The most common reason stock issued to the founders or early investors loses QSBS status is that the company redeems some stock to give founders liquidity. Not all redemptions disqualify QSBS so, if you want to redeem stock, it’s important to ensure that it’s structured correctly.
Qualified small business stock (QSBS) is a type of stock that is eligible for certain tax benefits under the Internal Revenue Code. QSBS is issued by qualified small businesses, which are generally businesses that are based in the United States and have gross assets of $50 million or less at the time the stock is issued.
Here are some key facts about QSBS and the tax benefits it provides.
QSBS provides a potential exclusion from federal income tax
If certain requirements are met, individuals who hold QSBS for more than five years may be able to exclude up to 100% of the capital gain on the sale of the stock from federal income tax. This exclusion is subject to certain limitations and conditions, such as a cap on the amount of gain that can be excluded and a requirement that the stock be issued by a qualified small business.
There are requirements for a stock to qualify as QSBS
In order to be considered QSBS, the stock must meet certain requirements, including:
The stock must be issued by a qualified small business that is engaged in an active trade or business. Technology startups generally qualify provided their lawyer effectively assists them in avoiding disqualification.
The stock must be acquired by the taxpayer from the company in exchange for money or other property (not including stock).
The stock must be held by the taxpayer for more than five years.
The tax benefits of QSBS can be significant
The potential tax benefits of QSBS can be significant, particularly for individuals who hold the stock for a long period of time and realize substantial capital gains on the sale of the stock. In some cases, the exclusion from federal income tax can result in significant savings on capital gains taxes.
Conclusion
Overall, qualified small business stock is a type of stock that is eligible for certain tax benefits under the Internal Revenue Code. If you receive QSBS from a startup or are considering investing in QSBS, it's important to understand the requirements for the stock to qualify as QSBS and the potential tax benefits that may be available to you. As always, it's recommended to consult with a qualified legal or tax professional before making any investment decisions or taking any tax-related actions.