A stock sale can produce millions of dollars of tax-free gain. And you don't have to do anything but choose the right structure. That is the power of…
A stock sale can produce millions of dollars of tax-free gain. And you don't have to do anything but choose the right structure. That is the power of qualified small business stock (QSBS).
The basic idea since the statute was introduced in 1993 has not changed: a noncorporate taxpayer acquires qualifying domestic C corporation stock directly from the corporation in exchange for money, other property (not stock) or as compensation. If the business and holding requirements are met, §1202 can exclude some or all of the gain from federal income tax.
When Does a Corporation Qualify for QSBS Treatment?
The corporation's aggregate gross assets, measured under §1202, cannot exceed $75 million at any time before issuance or immediately afterward. The ceiling is $50 million for stock issued on or before July 4, 2025.
During substantially all of the holding period, the corporation must remain a C corporation and meet the active-business rules. Generally, at least 80% of its assets by value must serve a qualified active business. Many service businesses (including accounting, law, health and consulting) and financial businesses are excluded.
How Does a Stockholder Qualify for QSBS Treatment?
Generally, the stockholder receives original-issue stock directly from the corporation. Buying another stockholder's shares usually does not qualify. Special rules can preserve qualification for gifts and certain other transfers.
For qualifying stock acquired after July 4, 2025, the stockholder must hold it for a specified period to get the exclusion:
• 3 to under 4 years: 50% exclusion.
• 4 to under 5 years: 75% exclusion.
• 5 years or more: 100% exclusion.
Stock acquired on or before July 4, 2025 generally must be held for more than five years. Its exclusion rate may be 50%, 75% or 100%, depending on acquisition date. Tax holding-period rules determine which regime applies; a qualifying gift generally carries over the donor's holding period.
What Are the Benefits to the Stockholder?
For newer stock, eligible gain is generally limited to the greater of $15 million or 10 times the adjusted basis of that issuer's QSBS sold during the year. The holding-period percentage applies to that eligible gain. The older dollar limit is $10 million. Prior eligible gain and mixed-date holdings affect the available limit.
The limitation is applied for each stockholder, for each corporation, not aggregated across a corporation's shareholders. The $15 million and $75 million amounts begin indexing in 2027. The rules are complex - it is easy to lose QSBS status. This is consult your advisor territory.
Using QSBS is one of the best tools for small companies that have a good chance of a future sale. Structure it right, and you can save millions too.
Secret Art of Planning | Adapted from my QSBS newsletter:
https://lnkd.in/eugBVSSz
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