Qualified Small Business Stock (QSBS) and Opportunity Zones (OZ) are tax codes enacted to fuel the job market and spark widespread economic growth. These tax codes also incentivize regional development in strategic areas, which creates an influx of capital and accessible work opportunities. Both of these tax diversification tools are composed of financial incentives that draw venture capital investors to potentially lucrative business ventures. QSBS and Opportunity Zone incentives may be utilized together depending on whether or not such business satisfies both OZ and QSBS requirements pursuant to their respective codes.
Defining QSBS and OZ
Before diving into how these two influential and versatile tax mechanisms can work together, let’s expound on how they function individually:
Qualified Small Business Stock (QSBS) is a tax incentive with IRC Section 1202 that offers eligible investors up to a 100% capital gains tax exclusion as long as qualifications are met at both a corporate level and a taxpayer level. The creation of this profitable tax exclusion stimulates an influx of capital investments into the startup marketplace.
- The stock was issued by a domestic US C-Corporation whose assets were less than $50M at the time of issuance.
- The company applied at least 80% of its valued assets to one or more “qualified” trades or businesses (under 1202(e)(3)) and made no disqualifying stock redemptions at the taxpayer level.
- The eligible stock was held for at least 5 years and obtained at original issue from the corporation.
Opportunity Zones (OZ) is a provision of 26 U.S.C. Sec. 1400Z-1 and 26 U.S.C. Sec. 1400Z-2. This tax incentive was also enacted to stimulate the national economy and enhance job generation and availability, specifically in distressed and low-income communities.
For a business to be considered a QOZB, it must meet these core requirements:
- 70% or more of QOZB assets must be considered QOZB property used for business and primarily utilized in OZ census tracts.
- 40% or more of intangibles within a QOZB must be utilized in OZ census tracts.
- 50% or more of the QOZB income must be associated with OZ-sourced income, which is determined within four sets of “safe harbor” rules located within the regulations.
- A “Safe Harbor Test” can be found here.
If a corporation is an eligible QOZB (Qualified Opportunity Zone Business), immediate tax incentives can be realized through capital gain deferral and long-term benefits can be obtained through tax-free appreciation.
QSBS and OZ at Work
With careful investment capital considerations and thorough business planning, investors can establish a qualifying QSBS entity inside a QOZB. Combining these tax provisions can give greater investment flexibility and more significant tax advantages, especially in exits occurring before ten but after 5 years.
GRASS the OZ Fund
An example of this tax incentive combination at work is in the growth and development of GRASS (Growth Resources, Assets, Safety, & Stability). This company is an OZ fund, and they promote themselves as a QSBS qualified business. They focus on capital investments and innovative developmental technologies centered around aviation like drones, aircraft hangers, and regulatory technology. GRASS also secured federal approval to launch a Reg A+ funding round back in June of 2021. The company is planning to invest in the Fernley and Silver Springs region in Nevada. Their goal is to invest in economic expansion and technological growth while also potentially benefiting from the advantages tied to Opportunity Zones. Overall, the company aims to utilize the advantages of crowdfunding, Opportunity Zones, and QSBS incentives to directly benefit the growth of GRASS and aid in the regional public and private sector economic growth and job creation.
Additional Advantages of Combined Tax Benefits
Qualifying for and utilizing eligible OZ benefits can also provide advantages at a federal and state level for qualifying corporations. These financial advantages include the ability to utilize certain grants and other exemptions, along with additional tax credits related to assets and hiring. Some states conform to the Federal Tax provision; however, some states either partially conform or do not conform at all.
The potentially profitable benefits of QSBS and OZ can stretch to founders and investors in the growing startup marketplace, incentivizing many to invest in strategic businesses in specific locations that need an economic influx to get off the ground. While these tax codes can be highly nuanced and tricky to navigate, our team here at CapGains.com is ready to assist in determining and maintaining eligibility throughout the entire lifetime of your investment stock.
Our team of QSBS experts here at Capgains.com specializes in aiding investors and corporations as they navigate QSBS tax exemption qualifications through ensuring shares are eligible and by monitoring QSBS stock eligibility over time.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.