The JOBS Act, or the Jumpstart Our Business Startups Act was signed into law by President Obama on April 5, 2012. The purpose of this legislation is to lessen stiff regulation in place by the Securities and Exchange Commission on small and growing businesses.
For companies with less than $1 billion in revenue, the JOBS Act requires less reporting and disclosure requirements to the Securities and Exchange Commission (SEC). It also gives small companies the opportunity to seek crowdfunding as a source of capital in addition to allowing them to offer stock for sale without going through the entire registration process with the SEC.
Before the JOBS Act, only accredited investors could invest in startups which made it highly inaccessible for main street investors to reap the benefits of section 1202 and Qualified Small Business Stock. Now, small companies with less than $1 billion in annual revenue can raise capital through crowdfunding, angel investors, small public offerings, and an increase in allowable private shareholders.
Because more individual investors have access to shares in these startups, more people can acquire stock that may qualify as QSBS according to the IRC.
How can Stock in a Startup Qualify for QSBS?
In order for shares to qualify as Qualified Small Business Stock under section 1202, the company or startup must be structured as a domestic C corporation rather than an LLC, partnership, or S Corporation.
The company must have less than $50 million in gross-assets according to an aggregate gross asset test found under Section 1202(d)(1)(B).
And finally, the company must be actively involved in a qualified trade according to the code. “Actively involved” means that 80% of the company’s assets are being used to run the business and, while section 1202 goes into great detail about unqualified trades, most product-based businesses and technology companies do qualify. More information related to Qualifying Industries can be found here.
What is the Benefit of QSBS?
If your stock meets the necessary qualification in section 1202, the benefits are immense. A taxpayer who received QSBS directly from a company, and holds onto said stock for a minimum of 5 years, can exclude up to $10 million or 10X—whichever is the greater amount—the adjusted basis of the stock from his or her taxable income. This 100% exclusion was added to the IRC by the American Taxpayer Relief Act of 2012 and then was made permanent by the PATH Act of 2015. Looking for specific advice on QSBS and Capital Gains?
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This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.