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QSBS: guide for founders

5 min of reading

QSBS: guide for founders

5 min of reading

QSBS: guide for founders

5 min of reading

The Qualified Small Business Stock (QSBS) provides substantial tax benefits under Section 1202 of the Internal Revenue Code for founders and investors in qualified small businesses. Here's a simplified guide to understanding QSBS and how it can benefit founders and angel investors.

The Qualified Small Business Stock (QSBS) provides substantial tax benefits under Section 1202 of the Internal Revenue Code for founders and investors in qualified small businesses. Here's a simplified guide to understanding QSBS and how it can benefit founders and angel investors.

The Qualified Small Business Stock (QSBS) provides substantial tax benefits under Section 1202 of the Internal Revenue Code for founders and investors in qualified small businesses. Here's a simplified guide to understanding QSBS and how it can benefit founders and angel investors.

Eligibility Criteria for QSBS

  1. The Issuing Company:

    • Must be a C-corporation.

    • Must be a domestic U.S. corporation.

    • Must have total gross assets of $50 million or less at the time of stock issuance and immediately after.

  2. The Stock:

    • Must be acquired at its original issue (directly or through an underwriter) in exchange for money, property (not including stocks), or as compensation for services to the corporation.

    • Must be held for at least five years.

  3. The Business:

    • Must be engaged in an active trade or business. Passive investment companies typically do not qualify.

    • At least 80% of the value of the corporation's assets must be used in the operation of a qualified trade or business during substantially all of the shareholder's holding period.

  4. Exclusion:

    • Up to 100% exclusion of the capital gains on the sale of QSBS, depending on when the stock was acquired:

      • 50% exclusion for QSBS acquired before February 18, 2009.

      • 75% exclusion for QSBS acquired between February 18, 2009, and September 27, 2010.

      • 100% exclusion for QSBS acquired after September 27, 2010.

    • The exclusion is subject to a cap of $10 million or 10 times the adjusted basis of the investment, whichever is greater.

Important Considerations

  • Holding Period: The five-year holding period is crucial. Selling before five years means losing the exclusion benefits.

  • AMT and NIIT: For QSBS acquired before September 27, 2010, some of the excluded gain may be subject to the alternative minimum tax (AMT) or the 3.8% net investment income tax (NIIT).

  • Rollovers: Under Section 1045 of the IRC, QSBS holders can roll over their investment to another QSBS within 60 days of sale and defer the capital gains tax, provided the original QSBS was held for more than six months.

Strategies for Founders and Angel Investors

  1. Early Planning: Determine if your corporation qualifies as a small business as early as possible to issue QSBS to founders and early investors.

  2. Holding Period: Make sure you understand the importance of the five-year holding period and plan your liquidity events accordingly.

  3. Estate Planning: Consider integrating QSBS into your estate planning to take advantage of the exclusion upon transfer to heirs or trusts.

  4. Documentation: Maintain thorough records from the issuance of the QSBS to substantiate qualification for tax benefits upon a sale or transfer.

  5. Diversification Strategy: Utilize Section 1045 rollovers to diversify your investments without immediate tax consequences.

  6. Consult Professionals: Regularly consult with tax advisors to navigate the complex rules surrounding QSBS and to keep abreast of any changes in legislation.

For founders and angel investors, QSBS provides a compelling tax advantage that can significantly enhance the returns on investments in qualified small businesses. Proper planning and adherence to the QSBS requirements are essential to fully leverage the benefits of this tax incentive.

Eligibility Criteria for QSBS

  1. The Issuing Company:

    • Must be a C-corporation.

    • Must be a domestic U.S. corporation.

    • Must have total gross assets of $50 million or less at the time of stock issuance and immediately after.

  2. The Stock:

    • Must be acquired at its original issue (directly or through an underwriter) in exchange for money, property (not including stocks), or as compensation for services to the corporation.

    • Must be held for at least five years.

  3. The Business:

    • Must be engaged in an active trade or business. Passive investment companies typically do not qualify.

    • At least 80% of the value of the corporation's assets must be used in the operation of a qualified trade or business during substantially all of the shareholder's holding period.

  4. Exclusion:

    • Up to 100% exclusion of the capital gains on the sale of QSBS, depending on when the stock was acquired:

      • 50% exclusion for QSBS acquired before February 18, 2009.

      • 75% exclusion for QSBS acquired between February 18, 2009, and September 27, 2010.

      • 100% exclusion for QSBS acquired after September 27, 2010.

    • The exclusion is subject to a cap of $10 million or 10 times the adjusted basis of the investment, whichever is greater.

Important Considerations

  • Holding Period: The five-year holding period is crucial. Selling before five years means losing the exclusion benefits.

  • AMT and NIIT: For QSBS acquired before September 27, 2010, some of the excluded gain may be subject to the alternative minimum tax (AMT) or the 3.8% net investment income tax (NIIT).

  • Rollovers: Under Section 1045 of the IRC, QSBS holders can roll over their investment to another QSBS within 60 days of sale and defer the capital gains tax, provided the original QSBS was held for more than six months.

Strategies for Founders and Angel Investors

  1. Early Planning: Determine if your corporation qualifies as a small business as early as possible to issue QSBS to founders and early investors.

  2. Holding Period: Make sure you understand the importance of the five-year holding period and plan your liquidity events accordingly.

  3. Estate Planning: Consider integrating QSBS into your estate planning to take advantage of the exclusion upon transfer to heirs or trusts.

  4. Documentation: Maintain thorough records from the issuance of the QSBS to substantiate qualification for tax benefits upon a sale or transfer.

  5. Diversification Strategy: Utilize Section 1045 rollovers to diversify your investments without immediate tax consequences.

  6. Consult Professionals: Regularly consult with tax advisors to navigate the complex rules surrounding QSBS and to keep abreast of any changes in legislation.

For founders and angel investors, QSBS provides a compelling tax advantage that can significantly enhance the returns on investments in qualified small businesses. Proper planning and adherence to the QSBS requirements are essential to fully leverage the benefits of this tax incentive.

Eligibility Criteria for QSBS

  1. The Issuing Company:

    • Must be a C-corporation.

    • Must be a domestic U.S. corporation.

    • Must have total gross assets of $50 million or less at the time of stock issuance and immediately after.

  2. The Stock:

    • Must be acquired at its original issue (directly or through an underwriter) in exchange for money, property (not including stocks), or as compensation for services to the corporation.

    • Must be held for at least five years.

  3. The Business:

    • Must be engaged in an active trade or business. Passive investment companies typically do not qualify.

    • At least 80% of the value of the corporation's assets must be used in the operation of a qualified trade or business during substantially all of the shareholder's holding period.

  4. Exclusion:

    • Up to 100% exclusion of the capital gains on the sale of QSBS, depending on when the stock was acquired:

      • 50% exclusion for QSBS acquired before February 18, 2009.

      • 75% exclusion for QSBS acquired between February 18, 2009, and September 27, 2010.

      • 100% exclusion for QSBS acquired after September 27, 2010.

    • The exclusion is subject to a cap of $10 million or 10 times the adjusted basis of the investment, whichever is greater.

Important Considerations

  • Holding Period: The five-year holding period is crucial. Selling before five years means losing the exclusion benefits.

  • AMT and NIIT: For QSBS acquired before September 27, 2010, some of the excluded gain may be subject to the alternative minimum tax (AMT) or the 3.8% net investment income tax (NIIT).

  • Rollovers: Under Section 1045 of the IRC, QSBS holders can roll over their investment to another QSBS within 60 days of sale and defer the capital gains tax, provided the original QSBS was held for more than six months.

Strategies for Founders and Angel Investors

  1. Early Planning: Determine if your corporation qualifies as a small business as early as possible to issue QSBS to founders and early investors.

  2. Holding Period: Make sure you understand the importance of the five-year holding period and plan your liquidity events accordingly.

  3. Estate Planning: Consider integrating QSBS into your estate planning to take advantage of the exclusion upon transfer to heirs or trusts.

  4. Documentation: Maintain thorough records from the issuance of the QSBS to substantiate qualification for tax benefits upon a sale or transfer.

  5. Diversification Strategy: Utilize Section 1045 rollovers to diversify your investments without immediate tax consequences.

  6. Consult Professionals: Regularly consult with tax advisors to navigate the complex rules surrounding QSBS and to keep abreast of any changes in legislation.

For founders and angel investors, QSBS provides a compelling tax advantage that can significantly enhance the returns on investments in qualified small businesses. Proper planning and adherence to the QSBS requirements are essential to fully leverage the benefits of this tax incentive.

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