Federal QSBS Exclusions and State Tax Implications
Allowing capital gains tax exclusions for Qualified Small Business Stocks (QSBS) encourages investment in US small business. QSBS laws help provide capital for these businesses while offering a savvy tax strategy for investors who want to minimize capital gains taxes.
Investors who hold qualified small business stock for at least 5 years can exclude up to $10,000,000 or more of their recognized capital gains from their taxable income if certain criteria are met.
Each state has its own treatment of QSBS gains at the state income tax level. There are three ways in which states typically address the exclusion.
- Some states fully conform to the Federal QSBS guidelines, and therefore allow a full exemption if the stock meets the Section 1202 QSBS criteria. States conform to the federal tax code on either a static or rolling basis. “Static” conformity means the state starts conforming to the Internal Revenue Code as of a specific date. “Rolling” conformity means that the state adopts IRC changes as they occur. Alternatively, certain states do not have state income taxes and therefore there is no QSBS implication at the state level.
- Some states partially conform to the Federal QSBS guidelines, whereby the capital gains from QSBS are exempt if additional criteria beyond the Federal guidelines are met, such as only allowing exemptions if the QSBS gains were from a company doing business in that state.
- Lastly, certain states do not allow any capital gains exclusions for QSBS.
Maryland QSBS Exemptions
Maryland follows the Section 1202 100% tax exclusion on capital gains from the sale of QSBS. Therefore, capital gains on the sale of QSBS will not only be excluded from federal income taxes, but also state income taxes if all of the guidelines are followed.
Maryland follows the “Rolling” conformity–as stated in the previous paragraphs. Maryland does, at the Corporate level, conform to the federal exclusion for gain from certain small business stock under section 1202. See Md. Code Ann., Tax-Gen. § 10-304. Maryland does, at the Individual level, conform to the federal exclusion for gain from certain small business stock under section 1202. See Md. Code Ann., Tax-Gen. § 10-203; I.R.C. § 1202.
Maryland Capital Gains Tax Rates
The state of Maryland taxes capital gains at the same rate as regular income. They have 8 tax brackets which range from 2% for individuals making less than $1,000 up to 5.75% for those earning over $250,000.
In comparison, federal capital gains tax rates only have 3 brackets for single taxpayers which are:
- 0% for $0 to $39,375
- 15% for $39,376 to $434,550
- 20% for $434,551 or more
Entrepreneurship in Maryland
The state of Maryland has more than 45 incubators and accelerators, many of which are focused on the bio/health and technology industries. You can find a comprehensive list of all of them through the Maryland Department of Commerce.
The Montgomery Innovation Network is an incubator which supports emerging technology, cybersecurity, life science companies as well as foreign companies looking to transition to the U.S. market. With locations across Maryland, the Network offers both physical space for these growing startups as well as services such as training seminars and networking events at no cost to the attendees.
Key Industries According to the Maryland Department of Commerce
Among other industries, the following industries in particular thrive in the state:
- Biohealth and Life Sciences
- IT and Cyber Security
- Advanced Manufacturing
- Military and Federal
- Aerospace and Defense
- Financial Services
- Energy and Sustainability
Other Programs Offered Besides QSBS that Support Entrepreneurship
From 2013 to 2019, the state of Maryland offered a Cybersecurity Investment Incentive Tax Credit which incentivized growth and innovation within this industry with a tax credit equal to the lesser of 33% of the investment or $250,000.
Beginning after July 1, 2021, the state will offer the Biotechnology Investment Incentive Tax Credit (BIITC) which will provide investors with a refundable State income tax credit for an eligible investment in a Qualified Maryland Biotechnology Company (QMBC). This credit’s purpose is to promote investments in early stage biotech companies in order to grow the biotech industry in Maryland.
Maryland Opportunity Zones
Maryland is home to approximately 149 Opportunity Zones census tracts and will be effective for 10 years.
Opportunity Zones (OZ) were created to help economically distressed areas by giving investors preferential tax treatment with new investments in these “specified” areas. Similar to QSBS, if the investment meets eligibility criteria and is held for at least 5 years, the investor can defer or be exempted from capital gains taxes (i.e. if held for at least 5 years, the taxpayer can exclude 10% of the gain and the percentage increases (or “steps up”) to 15% after 7 years).
Opportunity Zone investments can be in the stock of an OZ Qualified Business, an OZ partnership interest or an OZ business property.
To be a Qualified Opportunity Zone Business, the business must meet requirements such as at least 50% of the business’s total gross income being derived from within the Opportunity Zone. To learn more about Opportunity Zone qualifications, please refer to the Opportunity Zones and QSBS article.
Under the Tax Cuts and Jobs Act of 2017, 26 USC 1400Z-2, Maryland made Opportunity Zones, is also home to the associated tax relief incentives that accompany these zones which are effective for tax years beginning on or after December 31, 2017. Uniquely, Maryland has interactive resources for investors, fund managers, property developers, and many more in one place to show prospective zones to build the next project or business opportunity. A list of Maryland’s opportunity zones funding list can be found here.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.