Understanding the Qualified Small Business Stock (QSBS) Exclusion

Published: May 22, 2024 • M&A

If you are an entrepreneur, investor, or business owner, the Qualified Small Business Stock (QSBS) exclusion is an important tax benefit to understand. This powerful tax incentive, created by Congress in 1993 under Section 1202 of the Internal Revenue Code, allows taxpayers to potentially exclude up to 100% of the gain realized from selling QSBS held for more than 5 years. With proper planning, the QSBS exclusion can provide significant tax savings.

Contents

What is Qualified Small Business Stock (QSBS)?

Qualified small business stock (QSBS) is stock that meets certain requirements and is issued by a qualified small business (QSB) after August 10, 1993. To be considered QSBS, the stock must be:

  • Issued by a C corporation with less than $50 million in gross assets at the time of and immediately after stock issuance
  • Acquired by the taxpayer at original issuance, directly or through an underwriter, in exchange for money, property, or services
  • Issued by a company that uses at least 80% of its assets in the active conduct of one or more qualified businesses
  • Held by a non-corporate taxpayer (including individuals, trusts, and estates)

Requirements for Qualified Small Businesses (QSBs)

For stock to qualify as QSBS, the issuing company must meet the definition of a qualified small business (QSB). A QSB is a domestic C corporation that satisfies the following criteria:

  1. Aggregate Gross Assets: The aggregate gross assets of the corporation must not exceed $50 million at any time from August 10, 1993 through the stock issuance date. Aggregate gross assets include cash and the aggregate adjusted basis of other property held by the corporation.
  2. Active Business Requirement: At least 80% of the corporation’s assets must be used in the active conduct of one or more qualified trades or businesses. Qualified trades or businesses generally include any business other than:
  • Personal services (such as health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services)
  • Banking, insurance, financing, leasing, or investing
  • Farming
  • Mining or natural resource production or extraction
  • Operating a hotel, motel, restaurant, or similar business
  1. Ineligible Corporations: Certain types of corporations, such as DISCs (Domestic International Sales Corporations), RICs (Regulated Investment Companies), REITs (Real Estate Investment Trusts), and cooperatives, are not eligible to issue QSBS.

Holding Period and Exclusion Percentages

To qualify for the QSBS gain exclusion, the stock must be held for more than 5 years. The percentage of gain that can be excluded depends on when the stock was acquired:

  • Stock acquired between August 11, 1993 and February 17, 2009: 50% exclusion
  • Stock acquired between February 18, 2009 and September 27, 2010: 75% exclusion
  • Stock acquired on or after September 28, 2010: 100% exclusion

It’s important to note that the exclusion percentage is applied to the greater of $10 million or 10 times the aggregate adjusted basis of the QSBS sold in a given tax year.

Limitations on QSBS Gain Exclusion

While the QSBS exclusion can provide significant tax savings, there are several limitations to keep in mind:

  1. Per-Issuer Limitation: The amount of gain eligible for exclusion is limited to the greater of $10 million or 10 times the aggregate adjusted basis of the QSBS sold in a given tax year, on a per-issuer basis. This means that if an investor has QSBS from multiple companies, they can potentially exclude gain up to these limits for each company.
  2. Non-Corporate Taxpayers: The QSBS exclusion is only available to non-corporate taxpayers, such as individuals, trusts, and estates. Corporations, including S corporations, are not eligible for the exclusion.
  3. 28% Capital Gains Rate: A portion of the excluded gain may be subject to a 28% capital gains rate instead of the typical 20% rate. The 28% rate applies to the amount of gain that would have been recognized as ordinary income if the QSBS exclusion did not apply, typically due to depreciation recapture or other ordinary income items.
  4. Alternative Minimum Tax (AMT): For QSBS acquired before September 28, 2010, a portion of the excluded gain (7% for the 50% exclusion and 42% for the 75% exclusion) is treated as a preference item for Alternative Minimum Tax (AMT) purposes. This means that the excluded gain could potentially trigger AMT liability. However, QSBS acquired on or after September 28, 2010 (eligible for 100% exclusion) is not subject to AMT.

Qualifying for QSBS Treatment

To ensure that stock qualifies as QSBS, investors and businesses should consider the following:

  1. Original Issuance: The stock must be acquired directly from the issuing corporation at original issuance, either in exchange for money, property, or services. Stock purchased from another shareholder or on the secondary market does not qualify.
  2. Documentation: Maintain clear records of stock acquisitions, including the date of acquisition, the amount paid, and the fair market value of any property or services exchanged for the stock. These records will be essential for substantiating QSBS treatment when the stock is sold.
  3. Gross Asset Test: Monitor the corporation’s aggregate gross assets to ensure they do not exceed $50 million at any time before and immediately after stock issuance. If the corporation’s assets grow beyond this threshold, stock issued after that point will not qualify as QSBS.
  4. Active Business Requirement: Ensure that at least 80% of the corporation’s assets are used in the active conduct of one or more qualified trades or businesses. Regularly review the company’s activities and asset composition to confirm ongoing compliance with this requirement.
  5. Holding Period: Plan to hold QSBS for more than 5 years to qualify for the gain exclusion. If stock is sold before the 5-year holding period is met, the gain will be subject to regular capital gains tax rates.

Tax Planning Considerations

When planning for the QSBS exclusion, investors and business owners should consider the following:

  1. Timing of Stock Issuance: If a corporation is approaching the $50 million gross asset threshold, consider issuing stock before the threshold is crossed to ensure that the stock qualifies as QSBS. Once the threshold is exceeded, any stock issued thereafter will not be eligible for QSBS treatment.
  2. Structuring Investments: When investing in a startup or small business, consider whether a C corporation structure would be advantageous for potential QSBS benefits. While S corporations and LLCs offer pass-through taxation, they are not eligible to issue QSBS.
  3. Gifting QSBS: Gifting QSBS to family members or trusts can be an effective way to maximize the benefits of the gain exclusion. The recipient of the gifted stock retains the original owner’s holding period and basis, potentially allowing multiple taxpayers to exclude gain up to the $10 million or 10 times basis limit.
  4. Estate Planning: QSBS can be an valuable tool in estate planning, as the gain exclusion can significantly reduce the tax liability associated with the transfer of wealth to heirs. By holding QSBS until death, the stock receives a step-up in basis, potentially allowing heirs to sell the stock with little or no capital gains tax.

Conclusion

The Qualified Small Business Stock (QSBS) exclusion is a powerful tax incentive for entrepreneurs, investors, and small business owners. By meeting the requirements for QSBS and holding the stock for more than 5 years, taxpayers can potentially exclude up to 100% of the gain realized upon sale, subject to certain limitations. With proper planning and documentation, the QSBS exclusion can provide significant tax savings and help foster investment in small businesses and startups.

However, navigating the complex rules and requirements surrounding QSBS can be challenging. It’s essential to consult with a qualified tax professional to ensure compliance and maximize the benefits of the QSBS exclusion. By understanding the intricacies of QSBS and incorporating it into tax and estate planning strategies, investors and business owners can take full advantage of this valuable tax break.

FAQ

Here are 20 frequently asked questions about Qualified Small Business Stock (QSBS) with more detailed answers:

What happens if a company’s gross assets exceed $50 million after QSBS has been issued?

If a company’s gross assets exceed $50 million after QSBS has been issued, the stock will still qualify as QSBS. The $50 million gross asset limit applies only at the time of and immediately after the stock issuance. Once the stock has been issued, subsequent growth of the company’s assets will not disqualify the previously issued stock from QSBS treatment. However, any stock issued after the company’s gross assets exceed $50 million will not be considered QSBS, as it will not meet the initial issuance requirement.

Can QSBS be issued by an LLC or S corporation?

No, QSBS can only be issued by a C corporation. LLCs and S corporations are pass-through entities for tax purposes and are not eligible to issue QSBS. If a company is initially structured as an LLC or S corporation and wishes to issue QSBS, it would need to convert to a C corporation before issuing the stock. It’s important to note that the conversion process can be complex and may have significant tax consequences, so it’s essential to consult with a qualified tax professional before making any changes to a company’s structure.

How is the 5-year holding period calculated for QSBS?

The 5-year holding period for QSBS begins on the date the stock is acquired and ends on the date the stock is sold. The holding period is calculated using the trade date, not the settlement date. For example, if an investor purchases QSBS on January 1, 2023, and sells the stock on January 2, 2028, the holding period would be met, and the gain would be eligible for the QSBS exclusion (assuming all other requirements are met). If the stock were sold on December 31, 2027, the holding period would not be met, and the gain would be subject to regular capital gains tax rates.

Can QSBS be inherited?

Yes, QSBS can be inherited. When QSBS is inherited, the holding period of the deceased owner is added to the holding period of the inheritor, potentially allowing the inheritor to meet the 5-year holding period requirement. For example, if the deceased owner held the QSBS for 3 years before passing away, and the inheritor holds the stock for an additional 2 years before selling, the 5-year holding period would be met (assuming all other requirements are met). Additionally, QSBS receives a step-up in basis when inherited, which can significantly reduce the amount of gain recognized upon sale.

What happens if QSBS is sold before the 5-year holding period is met?

If QSBS is sold before the 5-year holding period is met, the gain will be subject to regular capital gains tax rates and will not be eligible for the QSBS exclusion. However, if the stock is sold at a loss, the loss can be used to offset other capital gains or up to $3,000 of ordinary income (for individual taxpayers). If the loss exceeds these limits, it can be carried forward to future tax years.

Can QSBS be sold in a private transaction?

Yes, QSBS can be sold in a private transaction, such as a sale to another individual or a private company. The sale does not need to occur on a public stock exchange for the QSBS exclusion to apply. However, it’s important to properly document the transaction and ensure that all requirements for QSBS treatment are met, including the 5-year holding period and the $50 million gross asset limit at the time of issuance.

How is the gain on the sale of QSBS calculated?

The gain on the sale of QSBS is calculated by subtracting the taxpayer’s basis in the stock from the sales price. The basis is generally the amount the taxpayer paid for the stock, adjusted for any stock splits, dividends, or other corporate actions. If the stock was received in exchange for property or services, the basis would be the fair market value of the property or services at the time of the exchange. It’s important to keep accurate records of the acquisition date, basis, and any adjustments to the basis to ensure proper calculation of the gain.

Can QSBS be used as collateral for a loan?

Yes, QSBS can be used as collateral for a loan. However, if the stock is pledged as collateral and the loan is defaulted on, resulting in the transfer of the stock to the lender, it may be treated as a sale of the stock for tax purposes. If this occurs before the 5-year holding period is met, the gain would not be eligible for the QSBS exclusion. It’s essential to carefully consider the potential tax consequences before using QSBS as collateral for a loan.

What happens if a company’s assets are used for non-qualified businesses?

For stock to qualify as QSBS, the issuing company must use at least 80% of its assets in the active conduct of one or more qualified trades or businesses. If a company’s assets are used for non-qualified businesses, such as personal services, banking, insurance, or investing, it may not meet the active business requirement. In this case, the stock would not be considered QSBS, and any gain on the sale of the stock would be subject to regular capital gains tax rates.

Can QSBS be issued by a foreign corporation?

No, QSBS can only be issued by a domestic C corporation, meaning a corporation incorporated in the United States. Stock issued by a foreign corporation, even if it meets all other requirements for QSBS treatment, would not qualify for the QSBS exclusion.

Can QSBS be transferred to a trust?

Yes, QSBS can be transferred to a trust. When QSBS is transferred to a trust, the holding period of the grantor is generally added to the holding period of the trust, potentially allowing the trust to meet the 5-year holding period requirement. However, the specific tax treatment of QSBS in a trust can be complex and may depend on the type of trust and the terms of the trust agreement. It’s essential to consult with a qualified tax professional and estate planning attorney to ensure proper structuring and compliance with QSBS requirements.

What happens if a company redeems QSBS from a shareholder?

If a company redeems QSBS from a shareholder, meaning the company buys back the stock, it may be treated as a sale of the stock for tax purposes. If the redemption occurs after the 5-year holding period is met, the gain may be eligible for the QSBS exclusion (assuming all other requirements are met). However, if the redemption occurs before the 5-year holding period is met, the gain would be subject to regular capital gains tax rates.

Can QSBS be exchanged for other stock in a tax-free transaction?

Yes, QSBS can be exchanged for other stock in a tax-free transaction, such as a merger or reorganization, without triggering a taxable event. In these cases, the holding period of the original QSBS would generally carry over to the new stock, potentially allowing the shareholder to meet the 5-year holding period requirement. However, the specific tax treatment of these transactions can be complex and may depend on the structure of the transaction and the type of stock received in exchange. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBS requirements and to minimize any potential tax liabilities.

What happens if a company goes public after issuing QSBS?

If a company goes public after issuing QSBS, the stock will generally retain its QSBS status, provided that all other requirements are met. However, once the company is publicly traded, any additional stock issued will not qualify as QSBS, as it will not meet the original issuance requirement. Shareholders who held QSBS before the company went public can still qualify for the QSBS exclusion on the gain from the sale of those specific shares, as long as the 5-year holding period and other requirements are met.

Can QSBS be gifted to charity?

Yes, QSBS can be gifted to charity. When QSBS is gifted to a qualified charitable organization, the donor may be eligible for a charitable deduction based on the fair market value of the stock at the time of the gift. Additionally, gifting QSBS to charity can be an effective way to avoid paying capital gains tax on the appreciation of the stock. However, it’s important to note that the charity must be a qualified 501(c)(3) organization and that the specific tax treatment of charitable gifts can be complex. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBS requirements and to maximize the tax benefits of charitable giving.

What happens if a company repurchases QSBS from a shareholder?

If a company repurchases QSBS from a shareholder, meaning the company buys back the stock, it may be treated as a sale of the stock for tax purposes. If the repurchase occurs after the 5-year holding period is met, the gain may be eligible for the QSBS exclusion (assuming all other requirements are met). However, if the repurchase occurs before the 5-year holding period is met, the gain would be subject to regular capital gains tax rates. It’s important to note that if the company repurchases a significant portion of its outstanding stock, it may be treated as a partial liquidation, which could have additional tax consequences. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBS requirements and to minimize any potential tax liabilities.

Can QSBS be rolled over into a new investment?

Yes, QSBS can be rolled over into a new investment, provided that certain requirements are met. Under Section 1045 of the Internal Revenue Code, a taxpayer who sells QSBS and reinvests the proceeds into another QSBS within 60 days of the sale may be able to defer the recognition of the gain. To qualify for this rollover treatment, the new QSBS must meet all of the same requirements as the original QSBS, including the $50 million gross asset limit at the time of issuance and the active business requirement. Additionally, the taxpayer must make an election on their tax return to apply the rollover treatment. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBS rollover requirements and to maximize the tax benefits of this strategy.

What happens if a shareholder dies while holding QSBS?

If a shareholder dies while holding QSBS, the stock will generally receive a step-up in basis to its fair market value at the time of the shareholder’s death. This means that when the shareholder’s heirs inherit the QSBS, their basis in the stock will be equal to the fair market value on the date of death, rather than the original basis of the deceased shareholder. This step-up in basis can significantly reduce the amount of gain recognized by the heirs upon the sale of the QSBS. Additionally, if the deceased shareholder had held the QSBS for more than 5 years at the time of death, the heirs may be able to exclude the gain on the sale of the stock under the QSBS exclusion (assuming all other requirements are met). It’s essential to consult with a qualified tax professional and estate planning attorney to ensure proper compliance with QSBS requirements and to maximize the tax benefits of this strategy.

Can QSBS be used in a 1031 exchange?

No, QSBS cannot be used in a 1031 exchange. A 1031 exchange, also known as a like-kind exchange, allows a taxpayer to defer the recognition of gain on the sale of certain types of investment property by reinvesting the proceeds into a similar property. However, this tax deferral strategy is limited to real property and does not apply to stocks, including QSBS. Taxpayers interested in deferring the gain on the sale of QSBS may be able to use the rollover provision under Section 1045 (as discussed in a previous question) or other tax planning strategies. It’s essential to consult with a qualified tax professional to explore the available options and to ensure proper compliance with tax requirements.

Can QSBS be issued by a company that is partially owned by a non-U.S. person?

Yes, QSBS can be issued by a company that is partially owned by a non-U.S. person, provided that the company is a domestic C corporation and meets all other requirements for QSBS treatment. The nationality of the shareholders does not affect the eligibility of the stock for QSBS treatment. However, it’s important to note that non-U.S. persons may be subject to different tax rules and reporting requirements when investing in U.S. companies and selling QSBS. It’s essential to consult with a qualified tax professional who is knowledgeable in international tax matters to ensure proper compliance with QSBS requirements and to minimize any potential tax liabilities.

Can a company issue QSBS and non-QSBS shares?

Yes, a company can issue both QSBS and non-QSBS shares. This may occur if the company issues shares before and after its gross assets exceed $50 million, or if the company issues shares for different purposes (e.g., cash investments vs. services rendered). It’s important to keep clear records of which shares qualify as QSBS and which do not, as the tax treatment of the shares will differ upon sale. The company should also ensure that it meets all other requirements for QSBS treatment, such as the active business requirement, for the shares to qualify as QSBS.

What happens if a company’s gross assets temporarily exceed $50 million?

If a company’s gross assets temporarily exceed $50 million and then fall back below the threshold, any stock issued while the gross assets were above $50 million will not qualify as QSBS. However, stock issued before and after the temporary increase in gross assets may still qualify as QSBS, provided that all other requirements are met. It’s important for companies to monitor their gross assets regularly to ensure compliance with the $50 million limit and to plan their stock issuances accordingly.

Can a taxpayer exclude gain from the sale of QSBS if they have already used their capital loss carryforwards?

Yes, a taxpayer can exclude gain from the sale of QSBS even if they have already used their capital loss carryforwards. The QSBS exclusion is not affected by the taxpayer’s use of capital loss carryforwards or other tax attributes. However, it’s important to note that if the taxpayer has net capital losses in the year of the QSBS sale, they may not be able to fully utilize the QSBS exclusion, as the exclusion cannot create a net operating loss. It’s essential to consult with a qualified tax professional to optimize the use of the QSBS exclusion and other tax strategies.

How do stock options and warrants impact QSBS treatment?

Stock options and warrants can qualify for QSBS treatment if they are exercised and the resulting stock meets all of the requirements for QSBS. The holding period for QSBS begins on the date the option or warrant is exercised, not the date it was granted. If the option or warrant is not exercised, it will not qualify for QSBS treatment. It’s important to keep clear records of the grant date, exercise date, and exercise price of stock options and warrants, as well as the fair market value of the stock on the exercise date, to ensure proper compliance with QSBS requirements.

Can a taxpayer exclude gain from the sale of QSBS if they are subject to the Net Investment Income Tax (NIIT)?

Yes, a taxpayer can exclude gain from the sale of QSBS even if they are subject to the Net Investment Income Tax (NIIT). The NIIT is a 3.8% tax that applies to certain investment income, including capital gains, for taxpayers with modified adjusted gross income above certain thresholds. However, gain from the sale of QSBS that is excluded under Section 1202 is not subject to the NIIT. This can provide significant tax savings for high-income taxpayers who hold QSBS. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBS requirements and to optimize the use of this tax strategy.

What happens if a company reincorporates in a different state after issuing QSBS?

If a company reincorporates in a different state after issuing QSBS, the stock will generally retain its QSBS status, provided that the company continues to meet all other requirements for QSBS treatment. The state of incorporation does not impact the eligibility of the stock for QSBS treatment, as long as the company is a domestic C corporation. However, it’s important to note that reincorporation may have other tax and legal consequences, such as changes in state tax liability or securities law compliance. It’s essential to consult with qualified tax and legal professionals to ensure proper compliance with all applicable requirements.

Can a taxpayer exclude gain from the sale of QSBS if they are subject to the Alternative Minimum Tax (AMT)?

The treatment of QSBS gain for Alternative Minimum Tax (AMT) purposes depends on when the stock was acquired. For QSBS acquired before September 28, 2010, a portion of the excluded gain (7% for the 50% exclusion and 42% for the 75% exclusion) is treated as a preference item for AMT purposes, meaning that it may be subject to AMT. However, for QSBS acquired on or after September 28, 2010 (eligible for the 100% exclusion), the excluded gain is not treated as an AMT preference item and is not subject to AMT. It’s essential to consult with a qualified tax professional to determine the specific AMT treatment of QSBS gain based on the acquisition date and other factors.

What happens if a taxpayer holds QSBS in a Roth IRA?

If a taxpayer holds QSBS in a Roth IRA, the gain from the sale of the QSBS may be tax-free if certain conditions are met. Roth IRAs are retirement accounts that are funded with after-tax contributions, and qualified distributions from Roth IRAs (including gains on investments) are generally tax-free. However, for the QSBS gain to be tax-free, the Roth IRA must have been open for at least 5 years, and the account holder must be over age 59½, disabled, or deceased. Additionally, the QSBS must meet all of the requirements for QSBS treatment, including the 5-year holding period. It’s essential to consult with a qualified tax professional to ensure proper compliance with Roth IRA rules and QSBS requirements.

Can a taxpayer exclude gain from the sale of QSBS if they are subject to state income tax?

The availability of the QSBS exclusion for state income tax purposes varies by state. Some states, such as New York and California, conform to the federal QSBS rules and allow taxpayers to exclude gain from the sale of QSBS for state income tax purposes. However, other states, such as Pennsylvania and Massachusetts, do not conform to the federal QSBS rules and may tax the gain from the sale of QSBS. It’s essential to consult with a qualified tax professional who is knowledgeable about the specific state income tax rules to determine the availability of the QSBS exclusion for state tax purposes.

What happens if a company issues QSBS and later becomes an S corporation?

If a company issues QSBS and later elects to become an S corporation, the stock will generally retain its QSBS status, provided that all other requirements for QSBS treatment are met. However, any stock issued after the company becomes an S corporation will not qualify as QSBS, as S corporations are not eligible to issue QSBS. It’s important to note that converting from a C corporation to an S corporation may have significant tax consequences, such as the recognition of built-in gains or the application of the LIFO recapture tax. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBS requirements and to minimize any potential tax liabilities.

Can a taxpayer exclude gain from the sale of QSBS if they are subject to the wash sale rule?

The wash sale rule generally does not apply to the sale of QSBS. The wash sale rule disallows the deduction of losses from the sale of stock or securities if the taxpayer acquires substantially identical stock or securities within 30 days before or after the sale. However, this rule does not impact the availability of the QSBS exclusion for gains. A taxpayer can still exclude gain from the sale of QSBS even if they acquire similar stock within the wash sale period. However, it’s important to note that if the taxpayer sells QSBS at a loss and acquires substantially identical stock within the wash sale period, the loss may be disallowed under the wash sale rule. It’s essential to consult with a qualified tax professional to ensure proper compliance with the wash sale rule and QSBS requirements.

What happens if a taxpayer holds QSBS in a grantor trust?

If a taxpayer holds QSBS in a grantor trust, the gain from the sale of the QSBS may be eligible for the QSBS exclusion, provided that all other requirements for QSBS treatment are met. A grantor trust is a trust in which the grantor (the person who creates and funds the trust) retains certain powers or control over the trust, causing the trust income to be taxed to the grantor rather than the trust itself. For QSBS purposes, the grantor is treated as the owner of the stock held by the grantor trust, and the grantor’s holding period and basis in the stock are used to determine eligibility for the QSBS exclusion. It’s essential to consult with a qualified tax professional and estate planning attorney to ensure proper compliance with grantor trust rules and QSBS requirements.

Can a taxpayer exclude gain from the sale of QSBS if they receive the stock as compensation for services?

Yes, a taxpayer can exclude gain from the sale of QSBS even if they receive the stock as compensation for services, provided that all other requirements for QSBS treatment are met. When stock is received as compensation for services, the taxpayer’s basis in the stock is generally equal to the fair market value of the stock on the date it is transferred to the taxpayer. This basis is used to determine the amount of gain eligible for the QSBS exclusion upon sale. It’s important to note that the receipt of stock as compensation may be subject to other tax rules, such as income tax withholding and employment taxes. It’s essential to consult with a qualified tax professional to ensure proper compliance with all applicable tax requirements.

What happens if a taxpayer holds QSBS in a charitable remainder trust?

If a taxpayer holds QSBS in a charitable remainder trust (CRT), the gain from the sale of the QSBS may be eligible for the QSBS exclusion, provided that all other requirements for QSBS treatment are met. A CRT is a tax-exempt irrevocable trust that provides a stream of income to one or more non-charitable beneficiaries for a specified period, with the remainder interest going to one or more charitable beneficiaries. When QSBS is sold within a CRT, the gain is generally not taxed to the trust or the beneficiaries at the time of sale. Instead, the gain is taxed to the non-charitable beneficiaries as they receive distributions from the trust. The QSBS exclusion may be available to the non-charitable beneficiaries when they report their share of the gain on their individual tax returns. It’s essential to consult with a qualified tax professional and estate planning attorney to ensure proper compliance with CRT rules and QSBS requirements.

Can a taxpayer exclude gain from the sale of QSBS if they acquire the stock through a tax-free merger?

Yes, a taxpayer can exclude gain from the sale of QSBS even if they acquire the stock through a tax-free merger, provided that all other requirements for QSBS treatment are met. In a tax-free merger, shareholders of the target company generally receive stock in the acquiring company in exchange for their target company stock, without recognizing gain or loss on the exchange. For QSBS purposes, the holding period and basis of the target company stock carry over to the acquiring company stock, allowing the shareholder to potentially qualify for the QSBS exclusion upon a later sale. It’s important to note that tax-free mergers can be complex transactions with significant tax consequences, and it’s essential to consult with a qualified tax professional to ensure proper compliance with all applicable tax requirements.

What happens if a taxpayer holds QSBS in a qualified opportunity fund (QOF)?

If a taxpayer holds QSBS in a qualified opportunity fund (QOF), the gain from the sale of the QSBS may be eligible for both the QSBS exclusion and the tax benefits provided by the QOF rules. A QOF is an investment vehicle that is designed to encourage investment in certain low-income communities designated as “opportunity zones.” Investors who reinvest capital gains into a QOF within 180 days of realizing the gain can defer tax on the reinvested gain until December 31, 2026, and may be able to exclude a portion of the deferred gain if they hold the QOF investment for at least 5 years. If the QOF invests in QSBS, the gain from the sale of the QSBS may also be eligible for the QSBS exclusion, provided that all other requirements for QSBS treatment are met. It’s essential to consult with a qualified tax professional to ensure proper compliance with QOF rules and QSBS requirements and to optimize the use of these tax incentives.

Can a taxpayer exclude gain from the sale of QSBS if they acquire the stock through an employee stock ownership plan (ESOP)?

Yes, a taxpayer can exclude gain from the sale of QSBS even if they acquire the stock through an employee stock ownership plan (ESOP), provided that all other requirements for QSBS treatment are met. An ESOP is a type of employee benefit plan that invests primarily in the stock of the sponsoring employer and provides employees with an ownership interest in the company. When an ESOP acquires QSBS, the employees who receive distributions of the QSBS from the ESOP may be able to exclude the gain from the sale of the stock, provided that they meet the 5-year holding period requirement and all other requirements for QSBS treatment. It’s important to note that ESOPs are subject to complex tax and ERISA rules, and it’s essential to consult with qualified tax and legal professionals to ensure proper compliance with all applicable requirements.

What happens if a taxpayer holds QSBS in a qualified small business investment company (QSBIC)?

If a taxpayer holds QSBS in a qualified small business investment company (QSBIC), the gain from the sale of the QSBS may be eligible for both the QSBS exclusion and the tax benefits provided by the QSBIC rules. A QSBIC is a type of investment fund that is licensed by the Small Business Administration (SBA) and invests primarily in small businesses. Investors in QSBICs may be able to deduct a portion of their investment as an ordinary loss, rather than a capital loss, if the QSBIC loses money. If the QSBIC invests in QSBS, the gain from the sale of the QSBS may also be eligible for the QSBS exclusion, provided that all other requirements for QSBS treatment are met. It’s essential to consult with a qualified tax professional to ensure proper compliance with QSBIC rules and QSBS requirements and to optimize the use of these tax incentives.

Can a taxpayer exclude gain from the sale of QSBS if they acquire the stock through a qualified equity grant?

Yes, a taxpayer can exclude gain from the sale of QSBS even if they acquire the stock through a qualified equity grant, provided that all other requirements for QSBS treatment are met. A qualified equity grant is a type of stock option or restricted stock unit (RSU) that is granted to an employee of a qualified small business and meets certain requirements under Section 83(i) of the Internal Revenue Code. Qualified equity grants allow employees to defer tax on the grant for up to 5 years, provided that certain conditions are met. If the stock received upon exercise of the option or settlement of the RSU is QSBS, the employee may be able to exclude the gain from the sale of the stock, provided that they meet the 5-year holding period requirement and all other requirements for QSBS treatment. It’s essential to consult with a qualified tax professional to ensure proper compliance with qualified equity grant rules and QSBS requirements.

What happens if a taxpayer holds QSBS in a qualified retirement plan?

If a taxpayer holds QSBS in a qualified retirement plan, such as a 401(k) or pension plan, the gain from the sale of the QSBS will generally be tax-deferred until the taxpayer takes a distribution from the plan. Qualified retirement plans are tax-advantaged investment vehicles that allow employees to save for retirement on a pre-tax basis, with taxes deferred until funds are withdrawn from the plan. When a qualified retirement plan invests in QSBS, the gain from the sale of the QSBS is not taxed to the plan or the participants at the time of sale. Instead, the gain is taxed to the participants when they take distributions from the plan, generally in retirement. The QSBS exclusion is not available for gain realized within a qualified retirement plan, as the gain is not taxed until distribution. It’s essential to consult with a qualified tax professional to ensure proper compliance with qualified retirement plan rules and to understand the tax treatment of QSBS held within such plans.