Tax break for qualified small business stock
Does your small business need a quick cash transfusion? One idea is to acquire more stock yourself or issue stock that is available to outside investors. Fortunately, the new tax law signed late last year—the Protecting Americans from Tax Hikes (PATH) Act—restores a big tax incentive for investing in a small business.
Specifically, the PATH Act restores the 100% tax exclusion for “qualified small business stock” (QSBS). As long as certain requirements are met, an investor can exclude 100% of the gain from tax that would have otherwise been incurred. This can be a prime attraction to investors.
Background: The tax break for QSBS has a long history. Prior to 2009, an investor could exclude capital gains tax on 50% of the gain from the sale of QSBS held at least five years. But the capital gains tax for investors in QSBS was 28%. In other words, you could exclude half of your gain from tax, but then the effective tax rate was still 14%, just 1% lower than the usual long-term capital gains tax rate of 15%.
Subsequently, the QSBS exclusion was raised to 75%. Then it was boosted to 100% for QSBS acquired after September 27, 2010, and extended through 2014. However, the 100% exclusion was scheduled to revert to 50% for 2015, barring any further legislative action.
Now the PATH Act has restored the 100% exclusion retroactive for QSBS acquired on or after January 1, 2015. What’s more, this tax break is now permanent. Investors do not have to worry about future changes.
But there are strict rules concerning the tax break for QSBS. To qualify for the exclusion, the following requirements must be met:
- The stock must have been held for five years and issued after August 10, 1993.
- The stock can’t be acquired in exchange for other stock.
- The issuing corporation must be a C corporation.
- At least 80% of the corporation’s assets must be used in the active conduct of a qualified trade or business.
- Certain businesses involving real estate or personal services (e.g., law, health, financial services, etc.) are excluded.
- The corporation can’t have more than $50 million in assets at the time the stock is issued.
Note that no current tax is due on a gain from the sale of QSBS if the investor rolls over the proceeds into new QSBS within 60 days. But you typically would not do this if you can benefit from the 100% exclusion.
Huddle with your professional advisers to see if this makes sense for you and your small company. It can provide an injection of capital when needed.