Income Insights: Sale of Qualified Small Business Stock

Sale of Qualified Small Business Stock

To encourage investment in U.S. small businesses and startups, Congress enacted Section 1202 of the Internal Revenue Code (IRC). Under this section, investors in Qualified Small Business Stock (QSBS) who meet the requirements can receive significant tax benefits.

Taxpayers who have held stock in a qualified small business (QSB) for more than five years may be eligible to exclude all or a portion of the gain associated with that stock. For purposes of Section 1202, a QSB is a business that meets these criteria:

• The company must be taxed as a domestic C corporation.
• The company’s aggregate gross assets must not exceed $50 million before and immediately after the stock issuance.
• The company must be engaged in a qualifying trade or business, and 80% of the company’s assets must be used in actively conducting one or more qualifying trades or businesses.

Per the IRC, a qualifying trade or business does not include businesses primarily engaged in performing services in certain fields, including health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business in which the principal asset is the reputation or skill of one or more of its employees. The definition of a qualifying trade or business also excludes any banking, insurance, financing, leasing, investing, or farming businesses and any hotel, motel, or restaurant.

Investors who sell QSBS and meet the holding period requirement can exclude a significant portion of their capital gains from federal tax when that stock is sold. The exclusion is first limited to the greater of $10 million in gains or 10 times the adjusted basis of the stock sold. The percentage of gain that can be excluded then depends on when the stock was acquired:

• Stock acquired between August 11, 1993, and February 18, 2009, is eligible for a 50% exclusion.
• Stock acquired between February 19, 2009, and September 27, 2010, is eligible for a 75% exclusion.
• Stock acquired on or after September 28, 2010, is eligible for a 100% exclusion.

Taxpayers who are ineligible for Section 1202’s capital gain exclusion solely because they don’t meet the five-year holding period requirement may be able to defer that gain-recognition event by using Section 1045, which provides tax benefits for rolling over proceeds from the sale of QSBS to purchase replacement QSBS.

In order to obtain the tax benefit under Section 1202, the taxpayer must report the gain and exclusion on Schedule D and Form 8949 of their income tax return for the tax year in which the QSBS is sold.

Allspring Global Investments does not provide accounting, legal, or tax advice or investment recommendations. Any tax or legal information on this page is merely a summary of our understanding and interpretations of some of the current income tax regulations and is not exhaustive. Investors should consult their tax advisor or legal counsel for advice and information concerning their particular situation.

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