Did you know gains on your stock may be 100% tax exempt? Qualified Small Business Stock (QSBS) is a tax provision (IRC Section 1202) that incentivizes capital investments in strategic innovation sectors to boost economic growth. QSBS can provide eligible investors up to a 100% capital gains tax exclusion if qualifying criteria are met – up to $2.38 million in savings for every $10 million in gains!
QSBS qualifications are highly nuanced, prompting thorough planning before tax filing. QSBS eligibility requires that stock is held for 5 years (i.e. for stock options the holding period generally starts on the date of exercise, not when granted).
Consider these 3 tax planning steps while preparing your taxes:
- Determine Your Exemption Percentage
The exemption percentage for a QSBS gain is based on when the stock was issued, and can provide a 50%, 75%, or 100% capital gains tax exclusion depending on the issuance date. However, the applicable percentage could change if a proposed amendment to QSBS passes as part of the Build Back Better Act. The change would reduce the exclusion percentage to 50% for gains earned after September 12, 2021, for taxpayers whose Adjusted Gross Income (including the QSBS gain) exceeds $400,000. While as of April 2022 this change has not been enacted, it is important to monitor as it can still be applied retroactively.
- Ensure Your Stock Meets QSBS Eligibility Requirements
Given the plethora of eligibility requirements at the corporate and taxpayer levels, it’s critical to ensure your exclusion claim is well supported.
- Corporate level (i.e. that the stock was issued by a domestic US C-Corporation whose assets were less than $50M at the time of issuance, the company applied just about all their assets to a “qualified” trade or business and made no disqualifying stock repurchases)
- Taxpayer level (i.e. that the stock was held for at least 5 years and obtained at original issue from the corporation)
As with any tax items, it is best to have your documentation in order. This is especially the case with tax exclusions such as QSBS.
- Properly File QSBS Exclusions on Your Taxes
QSBS gains are reported in 2 portions of a tax return:
Form 8949 is used to report ‘Sales and Other Dispositions of Capital Assets.’ Here, taxpayers report specific shares sold, date acquired and sold, gain amount, and cost basis. To adjust for the QSBS gain exclusion, note “Q” as the code in column (f) to indicate it is a “QSBS” gain and indicate the excluded amount in column (g) as a negative amount.
Details in Form 8949 flow to Schedule D, ‘Capital Gains and Losses.’ The total gains excluded for QSBS are reflected in column (g) of Schedule D.
Reference the IRS instructions on form 8949 and Schedule D for guidance on considerations like how to report installment sales, how to calculate taxes for non-excluded portions of gains in cases where the gains are not 100% exempt, and other situations.
QSBS requirements are complex, but given the magnitude of the potential exemption, attention to these factors and a small investment in performing a proper analysis could prove valuable in taking the appropriate steps to claim the exemption and in case of an audit.
For more, see these detailed tax filing instructions for Section 1202.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.