The answer is maybe…. because there are so many layers and nuances that make the tax code confusing. If you are unfamiliar with QSBS it stands for Qualified Small Business Stock and is regulated under Section 1202 of the IRC tax code. In short, QSBS is an exemption that allows for up to 100% in tax-free capital gains on the sale of the QSBS stock. To qualify for the exemption there are a few guidelines laid out with one of them being the legal structure of the business.
According to Section 1202, the small business must be a Domestic C Corporation and not an LLC. Although this is true there are some cases where a company that is an LLC could become QSBS eligible. The first instance is where a company is an LLC but is converted to a C Corporation. This is allowed if the right steps are taken, but the timeline for the QSBS will not start until the conversion. The other guideline to rope in is the holding period of the QSBS. QSBS must be held for five-years unless it is sold early and rolled into another investment under Section 1045.
The second instance is an LLC tax as a C Corporation. Based on prior case law the tax court allows the LLC to start the QSBS timeline but the company must be converted to a C Corporation before the equity is sold. This is because the LLC does not have stock but a member’s interest and in order to be QSBS, the company must issue stock.
Below are a few caveats to consider when determining if your stock or potential stock qualifies for the QSBS exemption:
- Entity structures that qualify for QSBS
- Size limit of a QSBS small business
- Qualifying QSBS industries
- Active business requirements
- Stock purchasing guidelines
- QSBS holding period
- QSBS gains excludable
- Reporting QSBS on your taxes
- QSBS exclusion for state taxes
- QSBS gain rollover
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.