With so many promising companies in the early stages of development, QSB stock gives everyday investors the chance to support the businesses they believe will be the next successful venture. With the attractive business tax benefits of qualified small business stock (QSBS) adding to the allure of investing in startups, QSBS is fast becoming a popular option for private shareholders looking to invest in shares with low minimum investment requirements.
For those who are not yet familiar with QSBS, it is helpful to understand what it is and what QSBS offers so you, too, can reap the benefits.
Breaking Down QSB Stock
Qualified small business stock (QSBS) refers to shares of stocks from qualified small businesses in the United States as defined under 1202 of the Internal Revenue Code. It is stock purchased from qualified small businesses after August 10, 1993. QSBS comes from any active domestic C corporation with assets valued at its original cost not exceeding $50 million soon after the stock issuance.
Qualified Small Business Eligibility Provisions
Qualified small businesses that may sell QSB stocks can include organizations in industries such as retail, manufacturing, and technology. It excludes hospitality, professional services (law, healthcare, architecture), agriculture, mining, and finance (banking and insurance). The companies, to be eligible, must use at least 80 percent of their assets actively in one or more of the qualified businesses and remain as a C corporation for the investor’s withholding period of the QSB.
QSB Tax Benefits
People who invest in QSBS can enjoy the following benefits:
- 100-percent exclusion from U.S. federal capital gains tax
- 100-percent exclusion from the AMT (alternative minimum tax)
- 100-percent exclusion from the 3.8 percent NIIT (net investment income tax)
However, for QSB stock issued before September 28, 2010, section 1202 gives a lower percentage tax exclusion, usually 50 or 75 percent. There is also a 28 percent tax rate for gain not excluded and subject to the NIIT.
Gain Exclusion Limitation
The tax savings under Section 1202 provide a generous limitation to the amount of gain from QSBS each taxpayer and issuer can exclude Section 1202 limits savings from business taxes of individuals to greater than:
- $10 million, or $5 million for married couples who are filing separately.
- Ten times the taxpayer’s combined basis in the amount of QSBS sold during the taxable year.
QSB Tax Exemption Eligibility Requirements
For individuals to claim the business tax benefits from a QSBS, they must meet the following requirements.
- The investor should be an individual, not a corporation.
- The investor should be US citizens or non-United States citizens living in the US.
- The investor must have purchased the stock directly from the company and not in a secondary market such as the New York Stock Exchange (NYSE) or NASDAQ.
- The investor must hold the QSBS for at least five years before selling and must have purchased the stock with either property, cash, or as a payment for service rendered. However, if the investor wants to sell the QSB stock before the required five-year holding period, the investor may avoid paying tax by investing the profit from the sale into another QSB stock granting the investor has held the QSB stock traded for over six months. If the QSBS meets these requirements, the investor has 60 days to complete the rollover into another QSB stock.
- The C corporation that issued the stock must use 80 percent of its assets in qualified trades of businesses.