Suppose you are a shareholder in a small company or a startup, its time to look more into QSBS as an opportunity to potentially enjoy tax benefits from the equity you have in those companies. QSBS, or Qualified Small Business Stocks, are stocks that can enjoy exclusions of up to 100% from paying federal capital gains tax. QSBS was initially instituted in 1993 to encourage people to invest in small businesses (click here), and startups are considered riskier. By 2010, the Small Business Jobs Act expanded the exclusions to 100% under certain conditions. What are the Benefits of QSBS? As an asset holder the benefits of QSBS, you can maximize the value of the equity in qualified QSBS through tax breaks once you sell them. With substantial tax breaks, investing in small companies and startups becomes more attractive to more people. Moreover, innovation and small companies are essential driving forces for the U.S. economy. With more capital coming into these companies, QSBS helps the U.S. economy grow and strengthen. Are Any Small Companies Eligible for QSBS Benefits? Not all companies are eligible for QSBS benefits. If the company's primary asset relies on the skill, reputation, and talent of one or a few of its employees, they are not eligible for QSBS benefits. The umbrella of companies that belong to these is from companies dealing in health, law, consultancy, sports, financial services, and more. Other company types not eligible for QSBS benefits belong to the farming, hospitality, and banking sectors. For a complete list of companies excluded from QSBS benefits, visit this link to the IRS site for details. To qualify for QSBS, the company should be incorporated as a C-corporation in the U.S. These companies should have gross assets not exceeding $50 million before or right after the equity was issued. A company may lose its eligibility if its 409A valuation exceeds the limits. However, shareholders can still enjoy the benefits of the tax exclusions before the company loses its eligibility status. How Do I Acquire QSBS Stock? Securities and negotiable instruments such as convertible debts should be converted to stocks before qualifying. To be eligible, you must be a person, a trust, or a through-entity to hold a QSBS stock. Moreover, you need to hold on to these stocks for five years to qualify for the tax benefit. Once the holding period elapses, you can enjoy up to 100% exclusion from having to pay capital gains from their federal taxes through selling options such as IPO events, bilateral secondary transactions, or directly selling your QSBS-eligible stocks. Once the stocks are QSBS-eligible, they will never lose their attributed tax benefits as long as Section 1202 of the IRS code remains in effect as written today. Even if the company is acquired by another company or involved in a merger, if the company's QSB status changes, or if the stocks are inherited or gifted, the stocks will never lose their attributed tax benefits as well. How are QSBS Shares Taxed? According to the provisions outlined in the Small Business Jobs Act of 2010, the capital gains exclusion is limited to $10 million or ten times the adjusted cost basis, whichever is greater. The regular capital gains tax rates are subjected to the excess gains that exceed this amount. The tax benefit also differs depending on when you acquired your QSBS stocks. You could enjoy the maximum benefits of the tax exclusion if you received your QSBS stocks after September 27, 2010. A smaller exclusion percentage is applied if you acquired your QSBS stocks before that date. Is the QSBS Tax Exclusion Uniformly Applied in All States and Territories? No. If the company is incorporated in California, Alabama, Mississippi, Pennsylvania, or Puerto Rico, your stakeholders won't be eligible for QSBS exclusion at the state level. Meanwhile, the states of Hawaii, New Jersey, and Massachusetts only partially conform with the QSBS tax exclusion with some modifications to the federal requirement. Takeaways Seeking advice from a qualified CPA or a tax advisor can help unlock your assets' potential, including QSBS. QSBS is one of the ways the government encourages people to help drive the economy forward through investing in small companies and startups. These small companies and startups are essential driving forces in the U.S. economy despite being riskier investment options than investing in more established companies. Aside from providing them with monetary benefits from tax breaks in their sales, helping small businesses thrive and survive in a competitive business environment will benefit the country. Awareness of QSBS is one of the ways people can consider when deciding where to place their investments.
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