What is QSBS?
According to the Internal Revenue Code, Qualified Small Business Stocks are the shares or stocks of qualified small businesses (QSBs). Qualified small businesses are active domestic C corporations whose gross assets, at their original cost, don’t exceed $50 million on and immediately after their stock issuance.
Understanding Qualified Small Business Stocks
To answer the question “what is QSBS?”, we need to understand what a Qualified Small Business Stock is! A QSBS is any stock attained from qualified small businesses as from the 10th day of August 1993. For an investor to claim their stock’s tax benefits, they have to meet the following qualifications:
• They must not be a corporation
• They must have acquired their share at the original issue and not from the secondary market
• They must have purchased the said stock with property or cash, or have accepted it as payment for some service
• They must have owned the stock for no less than five years
• At least eighty percent of the assets belonging to the issuing corporation must be used in the operations of several qualified businesses or trades
According to Section-1202 of the Internal Revenue Code, a qualified small business, and several types of companies qualify. For instance, companies in the financial sector, personal services, hospitality industry, mining, and farming aren’t eligible. Eligible companies include those in the wholesale, technology, manufacturing, and retail sectors.
– Qualified Small Business Stocks get preferential treatment when it comes to capital gains if both the company and the investor meet specific criteria.
– The amount of tax breaks investors receive is determined by when they purchased the particular stock and how long they’ve been holding on to it.
– An investor who sells their Qualified Small Business Stock before the stipulated holding period has ended can defer his or her capital gains by putting their proceeds in another business’ Qualified Small Business Stock.
Qualified existing business and startups looking to expand operations could raise additional or initial capital through a qualified small business stock offering. These businesses could also use QSBS as a type of ‘in-kind’ payment; which they may use to compensate employees for the services they offer when cash flow is restricted. A qualified small business stock can also be used as a way of retaining employees and as an incentive to help the business grow and be successful.
Tax treatment for qualified small businesses depends on when the company acquired the stock and how long it has held it. The PATH (Protecting American from Tax Hikes) Act of 2015 offers investors the chance to exclude one hundred percent of capital gains on their QSBS. However, the exclusion is capped at $10 million, or 10X the stock’s adjusted bases. Companies whose profits are above this amount are required to pay a 28 percent capital gains tax.
Furthermore, there are several holding requirements for the full exclusion of net investment income (NII) tax and alternative minimum tax (AMT). The alternative minimum tax is generally imposed on investors whose tax exemptions allow them to pay unusually low taxes for somebody at their income level.
Qualified small business stocks are tax benefits whose primary purpose is to encourage small businesses to take up long term investing. Gains on investments that qualify as qualified small business stocks can be eligible for deferred or reduced tax treatment. The information provided here should help answer your “what is QSBS” question. For more information on the matter, consult a tax or investments and securities specialist today.