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Qualified Small Business Stock (QSBS): The Last Great Windfall


There are very few large tax savings vehicles left but one of them, known as Qualified Small Business Stock (QSBS), continues to deliver significant tax savings to tech founders, private equity investors, and early stage investors in companies. QSBS has been a part of the tax code since the mid-90s and was passed to incentivize investment, attract capital to small innovative companies, and spur economic growth.

QSBS is stock in a small business company that may allow the owner to exclude all or part of the eventual gain upon sale of said stock. The exclusions range from a 50% exclusion all the way up to a 100% exclusion, for up to $10 million (or ten times your basis, whichever is greater) in life-time gains on stock from each C Corporation investment. For example, say an early stage investor in XYZ Co. invested $2 million back in 2014 and later sells the QSBS eligible stock for $12 million. The $10 million in gain could be completely free of federal income taxes: a tax savings of around $2.38 million at today’s long-term capital gains rates!

Below are the general requirements for eligibility for QSBS gains along with some advanced planning techniques to be aware of.

General Requirements for QSBS Stock Treatment

  • Investment must be in a domestic C Corporation.
  • Stock must be acquired at original issuance from the company (either by cash or property) or from the exercise of certain company stock options (for services).
  • Stock must have been issued after August 10, 1993.
  • The tax basis of assets in the company at all times prior to issuance of the stock must be less than $50 million.
  • This rule must remain true immediately after the issuance of stock (taking into account amounts received from the stock issuance).
  • The QSBS eligible corporation must be engaged in an active trade or business during substantially all of the taxpayer’s holding period.
  • QSBS stock must be held by the taxpayer for more than five years prior to the date of sale.
  • The taxpayer must be an individual, trust, estate, or certain pass-through entity. C corporations are not eligible for QSBS benefits.
  • Service businesses generally do not qualify (e.g. consulting, healthcare, accounting, actuarial services, law, and engineering) along with certain industries such as farming, banking, and financial services.

Special rules apply when a larger non-QSBS eligible company merges with or acquires a Qualified Small Business (QSB) company, and taxpayers should be especially mindful of the five year holding period requirement. Often an early exercise of stock options or conversion of certain debt investments in a QSB makes sense to get the clock running on the five year holding period.

Qualified small business stock provides for great tax planning opportunities, even after the life-time gain limit of $10 million is reached (remember this is on a by stock basis). For advanced strategies including gifting QSBS to trusts, rolling over QSB gains, and making use of the annual ten times basis limit, please reach out to your tax advisor at Berntson Porter.

Ordinary Losses on Small Business Investments

Apart from the potential for a tax exclusion, investment in small companies also has the unique benefit of a “heads you win, tails you win” structure with the provision of IRC Section 1244, Losses on Small Business Stock. Certain losses on investments in small businesses may be eligible for ordinary loss treatments (as opposed to capital loss) for up to $100,000 annually for married filing joint ($50,000 for single filers). Generally, at the time of the investment, the small business must have had a capitalization of under $1 million to be eligible for 1244 loss treatment.

For more information regarding QSBS investment treatment, please contact your Berntson Porter representative at 425-454-7990. We are here to help!

Berntson Porter is here to help businesses navigate these challenging times. Visit our Resource Center for up-to-date information about COVID-19 legislation that impacts you and your business. 


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