QSBS offers potentially lucrative tax breaks

Small businesses are recognized as one of the main drivers of economic growth. To spur investment in small companies, Congress offers attractive tax breaks for those investing in qualified small business stock.

Capital gains exclusions

Under Section 1202 of the Internal Revenue Code, investors who’ve held qualified small business stock (QSBS) for at least five years may be able to exclude from federal tax between 50% and 100% of their capital gain. The exclusion amount depends on when the QSBS was acquired:

• If the stock was acquired before February 18, 2009, 50% of the capital gain is excluded.
• If the stock was acquired between February 18, 2009, and September 27, 2010, 75% of the capital gain is excluded.
• If the stock was acquired on or after September 28, 2010, 100% of the capital gain is excluded.

The taxable portion of capital gains from a QSBS sale is taxed at ordinary income tax rates or 28%, whichever is less. So if the 28% tax rate and 75% exclusion applied to a sale of QSBS, the effective tax rate would be 7%. Meanwhile, the effective tax rate would be 14% if the 50% exclusion applied.
Also, capital gains excluded from federal tax aren’t subject to the 3.8% net investment income tax.

What are the criteria?

A business must meet specific criteria for its stock to be considered QSBS. For example, it must be a domestic C corporation and, at the time the stock is issued, can’t have more than $50 million in assets. In addition, at least 80% of the value of the business assets must be used in the active conduct of one or more qualified businesses.

The 100% exclusion window was set to expire at the end of 2014. But the Protecting Americans from Tax Hikes Act made the 100% exclusion permanent.

Is QSBS in your future?

Whether the QSBS exemption applies to you — or could apply — may have a significant impact on your future tax liability. Exploring the options now could lead to potential rewards down the road. •