The “17 Words” That Prove QSBS Is UNTOUCHED by Tax Hike
In the depths of the 107 page document titled, General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, released by the Department of the Treasury in May of 2021, you can find a simple statement that relieves a vast burden from those who work within the realm of Qualified Small Business Stock.
“Finally, the exclusion under current law for capital gain on certain small business stock would also apply.”
Page 63 of the document confirms to be true that the Biden administration’s financial proposal, while increasing tax rates on both income and capital gains for the wealthiest Americans, will not remove or decrease the financial incentive of investing in qualified small businesses.
What is the Incentive of Qualified Small Business Stock?
Qualified Small Business Stock is regulated by the Internal Revenue Service (IRS) under code Section 1202, offering tax benefits to accredited investors, investment funds, employees, and founders. QSBS is a federal tax benefit and, in some cases, can also extend to a state level. Check here to see if your state conforms to the federal code under section 1202.
The tax benefit can exclude up to 100% of capital gains on the sale of QSBS held for 5 years depending on what date the stock was originally issued. These tax savings can reach up to the greater of $10 million or 10x the initial investment, as long as the company qualifies as a qualified small business under the requirements found within Section 1202.
The History Behind QSBS
On January 24, 1963, John F. Kennedy stated,
“The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced by new ventures in obtaining capital, and thereby the strength and potential for growth of the economy.”
Exactly 30 years later, August 10, 1993, the Public Law No. 103-66 Title VIII Part II Subpart B – Capital Gains Provision was passed by the House of Representatives Budget Committee and added to the Internal Revenue Code (IRC) as Section 1202.4
The statute was introduced by a Minnesota House of Representative, Martin Olav Sabo, as an incentive for taxpayers to start and/or invest in certain small businesses with a goal to harvest innovative technologies. Since 1993, there has been a roller coaster of events leading up to today’s peak interest from investors for the Section 1202 capital gains tax exclusion.
In 2009, Congress increased the Section 1202 exclusion from 50% to 75%. Then, in 2010, Congress temporarily increased the exclusion from 75% to 100% . Finally, in 2015, the PATH Act was passed by Congress and made the Section 1202 100% exclusion permanent.
Who Will This Impact the Most?
While the incentives in Section 1202 regarding qualified small business stock are a benefit to all Americans including but not limited to accredited investors, investment funds, employees, and founders. American taxpayers who make over $1 Million in annual ordinary income have the most to gain by educating themselves of this obscure tax code.
The Biden administration’s proposal includes an increased federal tax rate on these taxpayers from 37% to 39.6% as well as an increased rate on capital gains taxes from 23.8% to 43.4% including surtax.
Taxpayers who tend to make their financial income in long term investments should understand the 100% federal tax exclusion that accompanies the successful sale of qualified stock after a 5 year holding period. Visit QSBSExpert to understand more about the qualifications and benefits of 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.